Brookfield Infrastructure Partners L.P. (BIP) is one of the fastest growing and most diversified utilities in the world. In fact, the limited partnership (a corporate structure similar to that of a Master Limited Partnership, or MLP) owns 35 infrastructure assets on five continents.
Some examples of the partnership’s assets include electrical transmission lines, railroads, toll roads, natural gas pipelines, global ports, telecom towers, and fiber optic lines.
As Brookfield points out, it essentially owns “critical and diverse infrastructure networks over which energy, water, goods, people and data flow or are stored.”
Brookfield Infrastructure Partners’ healthy diversification by business segment (no business unit is more than 25% of cash flow) and geography helps to ensure very stable cash flows to protect the safety and growth of its distribution (a tax-deferred form of dividend).
That’s especially true since 95% of the company’s cash flow is either secured by long-term, fixed rate contracts or derived in regulated industries. In addition, 75% of cash flow has escalators indexed to inflation, and 65% has no volume risk.
Brookfield Infrastructure Partners is structured as a limited partnership that’s sponsored by Brookfield Asset Management (BAM), the world’s oldest (115 years) and largest ($285 billion in assets) real estate, utility, and infrastructure investment firm.
Brookfield Asset Management owns 30% of the LP’s units and incentive distribution rights, or IDRs. The IDRs mean that 15% of distributions above $0.203 per quarter, and 25% of distributions above $0.22 per quarter, are paid to the sponsor (Brookfield Asset Management). These payments are in addition to the 1.25% of assets that Brookfield Asset management takes as its base fee.
In 2017, Brookfield Infrastructure paid a total of $113 million, or 3.2% of revenue, to Brookfield Asset Management.
In exchange, Brookfield Infrastructure investors gain access to one of the world’s most experienced management teams (average of 20 years of experience each) that can source highly profitable infrastructure deals in over 30 countries.
However, keep in mind that while Brookfield Infrastructure is much like an MLP, there are several important differences.
For example, the LP is designed to specifically not generate unrelated business taxable income, or UBTI. This makes the stock suitable for owning in retirement accounts such as IRAs.
More importantly, where most MLPs have incentive distribution rights that top out at 50%, Brookfield Infrastructure’s are half as large. This means that unit holders benefit from keeping 75% of all marginal adjusted funds from operations, or AFFO (similar to free cash flow for LP’s).
The lower IDRs also result in a lower cost of capital, which helps make Brookfield Infrastructure’s investments more profitable. In fact, Brookfield Infrastructure is currently enjoying a portfolio-wide AFFO yield on invested capital of 13%, well above its cost of capital.
That’s made possible for three main reasons. First, management is very disciplined about how fast it grows the distribution, making sure to retain about 30% of cash flow so that the LP can invest in future growth. In contrast, most MLPs retain just 10% to 20% of cash flow and are thus more dependent on debt and equity markets for growth capital. The more cash flow an LP retains, the lower its cost of capital and the more profitable its investments.
Brookfield Infrastructure also enjoys access to relatively low borrowing costs, which are the second reason for its low cost of capital and high profitability. This is thanks to the highly conservative nature of its balance sheet (credit rating BBB+). For example, 80% of the LP’s debt is fixed, with an average interest rate and duration of 4.6% and eight years, respectively.
More importantly, 80% of this debt is non-recourse, meaning that the debt is owned not by the LP itself, but by the individual assets whose cash flows service the loans. In the event that something goes wrong (such as a government nationalizing a toll road and cutting off the LP from its cash flow), the debt used to buy the asset will default. However, Brookfield Infrastructure’s creditors won’t be able to go after the LP’s other assets or cash flows.
In other words, Brookfield has essentially built a debt shield around investors and their distributions. Combined with the partnership’s relatively low payout ratio targeted at 60% to 70% of funds from operations (most utilities pay out 80% to 90% of earnings), this creates one of the industry’s safest income streams.
Finally, the greatest advantage Brookfield Infrastructure has is its sponsor’s proven ability to locate undervalued, cash-rich, and durable assets for it to buy. For example, in the last five years alone Brookfield Asset Management has sourced $7.7 billion in lucrative deals. Their attractive economics can be seen in the partnership’s average five-year EBITDA margin of 55%, as well as its average 12.4% AFFO yield.
In recent years, those investments have been even more profitable, and when the utility does occasionally sell something (opportunistic capital recycling to fund more growth), it usually does so while generating 16% to 25% post-tax internal rates of return.
But the biggest reason to consider Brookfield Infrastructure isn’t just its impressive management team, but the meaningful long-term growth opportunities that the utility can take advantage of.
For example, the LP currently has a $2.6 billion backlog of organic growth projects it’s working on. This means expanding or improving its existing assets in the next two to three years. Beyond that time frame, management has a shadow pipeline of projects its considering totaling another $1.2 billion.
Backing this organic growth is $3 billion in current liquidity (cash + remaining credit facility borrowing power). This strong ability to reinvest in its own cash-rich assets is partially why Brookfield expects to generate 6% to 9% annual growth in cash flow per unit over the long-term.
That 6% to 9% organic growth rate is faster than almost any utility in the world. Better yet, it’s sufficient to meet management’s long-term payout growth target of 5% to 9% a year. Brookfield believes that its combination of a generous and fast-growing dividend is capable of generating 12% to 15% annual total returns for shareholders over the long term.
Since its IPO 10 years ago, management has exceeded that target by an impressive amount and generated total returns far in excess of its peers.
And there is reason to believe that Brookfield Infrastructure, while unlikely capable of further 20% returns, could achieve its ambitious return guidance.
That’s because Brookfield’s organic growth potential is also augmented by management’s strong track record of major growth-boosting deals. For example, in 2017 Brookfield acquired $1.75 billion of outside assets. The most important deal was Brookfield’s $5.2 billion purchase of the Brazilian national oil company Petrobras’ natural gas pipeline system, which sent utility segment FFO up 67%. Brookfield’s stake in that deal was $1.3 billion, and it was the cornerstone of the company’s strong 2017 growth in which AFFO per unit increased 12.5%.
Management is currently looking to buy Gas Natural S.A. ESP (GN Colombia), the second largest natural gas distribution system in Colombia. This represents a potential $600 million purchase, of which Brookfield Infrastructure would contribute $170 million for its 28% stake in the deal.
Looking forward, the scale of Brookfield’s potential addressable market is truly staggering.
For instance, in North America, Australia, and Europe, it’s estimated that over $5 trillion will need to be spent on upgrading, expanding or building new infrastructure by 2025.
And when you consider the fast-growing emerging economies of the world, including China, India, Latin America, and Africa, Brookfield’s growth potential appears even vaster. Management estimates that by 2030 the need for infrastructure investment of all kinds (transportation, communication, water, energy) globally will come to about $36 trillion.
To put that in perspective, that figure is about 50% of the $78 billion estimated 2017 Global GDP. It’s also roughly 5,000 times what Brookfield Infrastructure has invested to date since its IPO.
The bottom line is that Brookfield Asset Management is a highly diversified, well-managed, and fast-growing utility with a generous payout. Its global scope means it’s likely capable of generating industry-leading income growth and healthy total returns for years to come.
However, as promising as Brookfield Infrastructure may be, there are still some risks to keep in mind before investing.
There are two things to consider with Brookfield Infrastructure’s distribution that might turn off some income investors.
First, due to the way the LP is structured, it does issue a K1 form because most of the payout is considered a return of capital by the IRS. This means that you don’t get taxed on this portion of the distribution, but rather it deducts from your cost basis and you pay capital gains on it later. Some investors prefer to not deal with the added tax complexity of K1 forms, though they generally only take a few minutes to account for using Turbotax.
In addition, BIP will withhold 15% of its distribution to U.S. investors for Canadian taxes. Fortunately, due to a tax treaty with Canada, U.S. investors can deduct this dollar for dollar as part of the foreign withholding tax credit. In fact, U.S. investors can offset $300/$600 (individuals/couples) of foreign dividend tax withholdings across their entire portfolio. This essentially means that instead of paying the IRS they are paying the Canadian government, at least on the non-return of capital portion of their distributions.
As to the risks specific to the partnership, there are several to keep in mind. For one thing, Brookfield’s international scope means that there is substantial foreign currency risk. The LP does use hedging to mitigate this, but 43% of cash flow is unhedged in foreign currencies such as the Brazilian Real, Indian Rupee, and Colombian Peso.
If the U.S. dollar appreciates significantly against these currencies, than Brookfield could see a potentially significant portion of its cash flows decline from assets in these countries.
Next, some of Brookfield’s investments in various emerging markets could be at risk of nationalization. After all, South America has a history of political upheaval and populist governments seizing foreign owned assets.
The risks are highest during times of economic distress when local politicians can often make foreign-owned infrastructure a scapegoat for high costs of essential utility and transportation services. The good news is that literally no company has better experience in operating in such potentially treacherous and volatile political environments.
However, even the well-run Brookfield sometimes runs into trouble. For example, Brookfield had planned to invest $200 million to buy a stake in 40,000 telecom towers in India. However, that deal was contingent on the merger between Indian telecom giants Reliance Communications and Aircel. When that larger merger fell apart, so did Brookfield’s deal.
Investors need to realize that Brookfield’s impressive past growth, including 20% payout increases in its early years, may not be repeated. Those were largely driven by needle-moving deals at a time when the partnership was much smaller, resulting in remarkable AFFO per unit growth that will be very hard to recreate now that Brookfield’s assets have swollen to $27 billion.
This is especially true given that the vast majority of Brookfield Infrastructure’s growth has occurred in a time of record-low interest rates. Brookfield will likely enjoy access to low-cost capital thanks to its disciplined use of debt and its affiliation with Brookfield Asset Management. However, a higher cost of debt in the future means that its returns on invested capital are likely to be smaller than the double-digit returns its been enjoying in the past few years.
Investors also need to remain aware that Brookfield is dependent on somewhat favorable capital market conditions; since it pays out the majority of its cash flow, Brookfield relies on consistently issuing new units and debt to finance much of its growth. Should affordable capital become harder to access, such as during a recession, it’s not out of the question that Brookfield’s distribution could come under pressure if management has extended the business too far (i.e. taken on too much debt).
Closing Thoughts on Brookfield Infrastructure Partners
For a utility, Brookfield Infrastructure Partners arguably offers some of the best cash flow diversification and long-term growth potential.
The partnership’s experienced management team, access to low-cost capital, and deal flow provided by Brookfield Asset Management mean that this utility is likely to enjoy offering a generous and fast-growing payout in the years ahead.
As long as you’re comfortable with the LP corporate structure and the inherent tax complexity and capital-raising risk that comes with it, Brookfield Infrastructure could be a reasonable long-term high-yield income investment to consider.
To learn more about Brookfield Infrastructure Partners’ dividend safety and growth profile, please click here.