Infrastructure for Sleeping Well at Night: Brookfield Enterprise Products and Infrastructure (BIP)

As we discussed the other day, infrastructure is one of our favorite sectors to invest in right now at High Yield Investor. The reasons are:

1. The demand for new infrastructure is fueled by strong economic growth in developing markets.
2. Developed economies need to quickly replace aging and increasingly obsolete infrastructure.
3. New types of infrastructure (like data centers for example) are in high demand due to the onset of the 4th Industrial Revolution.
4. The de-globalization trend that prioritizes the installation of critical infrastructure in geopolitically less sensitive areas.
5. Decarbonization also creates trillions of dollars of new demand for green infrastructure.
6. Interest rates are nearing their peak and the short-term economic outlook is bleak, creating attractive risk-adjusted valuations for some publicly traded infrastructure stocks.
7. Demographic trends put pressure on pensions funds to invest in high-return, long-term and reliable investments such as infrastructure. Therefore, the demand for these investments will likely increase in the coming years, driving up valuation multiples.

In this article, we’ll take a closer look at two of our favorite long-term wealth creators and distribution producers in the infrastructure space.

#1. Enterprise Product Partners (NYSE:EPD)

EPD is arguably the best publicly available investment opportunity for retirees. It benefits from a very attractive, safe and growing current distribution that yields 7.6% over the current unit price, an exceptional balance sheet that earns it the best BBB+ credit rating from S&P and class management. that is very well-aligned with unitholders (insiders own about a third of the partnership).

EPD’s underlying performance is largely the result of management’s skillful construction of a portfolio of world-class, prudently managed and strategically located mid-tier infrastructure assets, alongside an enterprise marketing which further improves the yields of its physical infrastructure.

The quality of EPD is demonstrated by the fact that it has generated very stable cash flows through all kinds of economic cycles, as illustrated in the table below:

EPD has experienced only very minor and short-lived declines in EBITDA since the turn of the century and has continued to increase its distribution per unit every year for almost a quarter of a century as well. This is in stark contrast to several of its peers who have been forced to inflict massive and devastating distribution cuts on investors over the years, including giants like Kinder Morgan (KMI), Energy Transfer (ET) and Plains All-American ( PAA) (PAGP).

Today, its portfolio has grown to include a diverse pipeline network that touches every ethylene cracker and every major shale basin in the United States, has export facilities strategically located on the Gulf Coast and owns a vaunted petrochemical business that management pursued ahead of many peers. . Its cash flows are largely resilient to commodity prices and largely benefit from long fixed cost terms and firm purchase terms.

Going forward, management is well positioned to continue investing in its portfolio opportunistically with a very low leverage ratio of 3.1x, cash of $3.3 billion and a weighted average duration of debt. until maturity in 20 years. Its distribution coverage ratio of 1.8x and its substantial free cash flow generation give it even more ability to seize the opportunities that arise.

That said, EPD management has been very conservative in capital allocation, delivering double-digit returns on invested capital across a wide variety of macro and energy sector conditions. Unitholders can therefore be assured that management will only pursue growth if it is likely to generate long-term value for them. Management always has the option of repaying maturing debt, repurchasing units and/or accelerating distribution growth if it is unable to find sufficient growth investment uses for the capital.

Overall, it’s hard not to like the EPD right now, especially since it’s trading at a discount to all of its BBB+-rated midrange peers (i.e. TC Energy (TRP), Enbridge (ENB) and Magellan Midstream (MMP)) as well as relative to its own five-year average EV/EBITDA multiple (9.5x running and 10.5x five-year average).

#2. Brookfield Infrastructure (New York Stock Exchange: BIP)(BIPC)

BIP has one of the most impressive long-term performance records in the entire infrastructure sector, generating total returns that have more than tripled those of the S&P 500 (SPY) since its IPO:

Meanwhile, its distribution growth has been nearly as impressive, growing its distribution per unit at a CAGR of around 10% since its IPO.

The secret behind this phenomenal success was a formidable capital allocation strategy that maximized the competitive advantages made available to the partnership through the support of its parent company Brookfield (BN)(BAM).

BIP combines its own equity with Brookfield’s institutional funds and large amounts of non-recourse fixed rate debt primarily at the long-term asset level to buy stakes in proprietary deals that would otherwise not be available to it and often have a limited competition. As a result, it does not engage in costly bidding wars for assets and often buys assets at a discount due to temporary circumstances that Brookfield believes it can rectify through its operational expertise, economies of scale, its access to low-cost capital. , and/or its extensive global sales network. Once the business plan is executed, BIP will often exit its stake at a profit alongside returns on equity which have been further amplified due to the large debts that are typically used to fund its investments.

At the same time, its balance sheet is protected against interest rate volatility due to the high percentage of fixed rate debt (90%) it holds and the weighted average term of its debt to maturity over seven years. . In addition, 70% of its cash flows are indexed to inflation, which gives it remarkable resistance to inflationary pressures. Last but not least, the fact that 85% of its debt is non-recourse, asset-wise, even if any of its businesses were to experience insurmountable macroeconomic headwinds, whether on the interest rate/refinancing front debt or on the operational front, it can still simply hand over the asset to the lender, while avoiding liability spreading to the rest of society. This strategic structuring of BIP’s balance sheet and cash flow profile helps limit the company’s overall long-term downside risk.

This all equates to a company that can leverage its unique competitive advantages to play an aggressive attack on behalf of its equity investors while sleeping well at night, knowing that its downside risk is ultimately capped by its conservative balance sheet structure.

Additionally, BIP is able to create significant value for its equity investors as its reputation and track record has earned it a premium multiple on its cash flow. Therefore, he can buy businesses at a price that is usually significantly lower than the multiple he will get once integrated into the Brookfield empire.

To illustrate this more clearly, take a look at each of BIP’s investment sectors and compare their valuations to those of their relevant peers.

Click to enlarge

In fact, this shows that an approximate fair value EV/EBITDA multiple for BIP based on a sum of its parts analysis is 14.3x. However, in reality, BIP is currently trading for an EV/EBITDA multiple of 19.5x, indicating that the valuation multiple that Mr. Market applies to its underlying business is much higher than what they are currently selling alone. in public markets today. . As a result – as long as it continues to benefit from that bullish Mr. Market sentiment – by simply buying companies at a price close to their listed value, BIP can generally create significant value for its equity investors.

Key takeaway for investors

At High Yield Investor, we love investing in infrastructure. In fact, we just bought some more yesterday. In this article, we’ve shared two of the best long-term preparers in the space in BIP/BIPC and EPD.

BIP/BIPC continues to generate solid growth alongside decent current performance. That said, however, we don’t think it’s particularly cheap at the moment and believe the EPD offers investors a better risk-reward ratio. It’s true that BIP/BIPC derives much of its value from its parent company Brookfield’s superior access to deal flow and capital which management skillfully leverages to generate strong growth rates over time. Therefore, we believe that BIP/BIPC deserves a valuation premium.

However, as we have explored in this article, its sum-of-its-parts valuation looks very rich compared to a similar compilation of assets purchased individually from other high-quality firms specializing in these specific industries. We believe that there is certainly no built-in safety margin in the current valuation and it can even be argued that the stock is currently overvalued. Accordingly, we price BIP/BIPC as a Hold and EPD as a Buy and hold it as a key part of our retirement portfolio at High Yield Investor.

Editor’s Note: This article discusses one or more securities that do not trade on a major US exchange. Please be aware of the risks associated with these actions.