Sleep Well At Night Infrastructure: Enterprise Products & Brookfield 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 for this are:

1. Demand for new infrastructure is being fueled by strong economic growth in developing markets.
2. Developed economies are having to rapidly replace aging and increasingly obsolete infrastructure.
3. New types of infrastructure (such as data centers for example) are in high demand due to the onset of the 4th Industrial Revolution.
4. The de-globalization trend that is prioritizing the installation of mission-critical infrastructure in less geopolitically sensitive areas.
5. Decarbonization is also creating trillions of dollars in new demand for green infrastructure.
6. Interest rates are nearing their peak and the near-term economic outlook is gloomy, creating attractive risk-adjusted valuations in some publicly traded infrastructure securities.
7. Demographic trends are putting pressure on pension funds to invest in high yield, long-duration, and reliable investments like infrastructure. As a result, demand for these investments will likely increase in the coming years, driving up valuation multiples.

In this article, we will look in more depth at two of our very favorite long-term wealth compounders and distribution growers in the infrastructure space.

#1. Enterprise Products Partners (NYSE:EPD)

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

EPD’s underlying performance is largely the result of management skillfully building a portfolio of world-class, conservatively run, and strategically located midstream infrastructure assets alongside a marketing business that further enhances returns on its physical infrastructure.

EPD’s quality is demonstrated by the fact that it has generated very stable cash flows through all sorts of business cycles as depicted in the chart below:

EPD has only seen very minor and short-lived declines in EBITDA since the turn of the century and has continued to grow its distribution per unit every single year for nearly a quarter century as well. This stands in stark contrast to several of its peers who have been forced to inflict massive and devastating distribution cuts to 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 diversified pipeline network that touches every ethylene cracker and every major shale basin in the United States, has strategically located exported facilities on the Gulf Coast, and has a vaunted petrochemical business that management pursued before many peers did. Its cash flows are largely commodity price resistant and largely benefit from lengthy, fixed-fee, take-or-pay terms.

Moving forward, management is well-positioned to continue investing in its portfolio opportunistically thanks to a very low 3.1x leverage ratio, $3.3 billion in liquidity, and a weighted average debt term to maturity of 20 years. Its 1.8x distribution coverage ratio and substantial free cash flow generation give it even more capacity to take advantage of opportunities as they come its way.

That said, EPD’s management has proven to be very prudent in allocating capital, generating double digit returns on invested capital through a wide variety of macroeconomic and energy industry conditions. As a result, unitholders can rest assured that management will only pursue growth if it is likely to generate long-term value for them. Management always has the option of retiring maturing debt, buying back units, and/or accelerating distribution growth if it fails to find sufficient growth investment uses for the capital.

Overall, it is hard to not like EPD right now, especially given that it trades at a discount to all of its BBB+ rated midstream 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 current and 10.5x five year average).

#2. Brookfield Infrastructure (NYSE:BIP)(BIPC)

BIP has one of the most impressive long-term track records space across the entire infrastructure sector, generating total returns that have more than tripled those of the S&P 500 (SPY) since it went public:

Meanwhile, its distribution growth has been nearly as equally impressive, growing its distribution per unit at a ~10% CAGR since going public.

The secret behind this phenomenal success has been a tremendous capital allocation strategy that has maximized the competitive advantages made available to the partnership via support from its parent Brookfield (BN)(BAM).

BIP combines its own equity with Brookfield’s institutional funds and large amounts of primarily long-term asset-level non-recourse fixed-rate debt to purchase stakes in exclusive deals that would not be available to it otherwise and often have limited competition. As a result, it does not get into costly bidding wars for assets and instead often purchases assets at a discount due to some temporary circumstance that Brookfield is confident that it can rectify through its operational expertise, economies of scale, access to low-cost capital, and/or its vast global business network. Once the business plan has been executed, BIP will often then exit its stake at a profit alongside equity returns that have been magnified to an even greater extent thanks to the large amounts of debt that are typically used to finance its investments.

Meanwhile, its balance sheet is protected against interest rate volatility due to the high percentage of fixed rate debt (90%) it holds and its seven year weighted average debt term to maturity. Furthermore, 70% of its cash flow is indexed to inflation, making it remarkably resilient in the face of inflationary pressures. Last, but not least, the fact that 85% of its debt is non-recourse, asset-level, even if one of its businesses were to suffer from insurmountable macroeconomic headwinds on either the interest rate/debt refinancing front or on the operational front, it can always simply hand over the asset to the lender, while preventing the liability from extending to the rest of the corporation. This strategic structuring of BIP’s balance sheet and cash flow profile helps to keep the overall long-term corporate downside risk limited.

What this all adds up to is a company that can leverage its unique competitive advantages to play aggressive offense on behalf of its equity investors while still sleeping well at night knowing that its downside risk is ultimately capped by its conservative balance sheet structure.

Furthermore, BIP is able to create significant value for its equity investors because its reputation and track record have earned it a premium multiple on its cash flows. As a result, it can buy businesses at a price that is generally significantly less than what multiple it will command 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 relevant peers’

Business Segment	Exposure	Fair Value Multiple	Peer Comparison	Fair Enterprise Value
Midstream	30%	12.6x	ENB	$12.9B
Utilities/Residential	30%	10.9x	OTCPK:CDUAF	$11.1B
Transportation	30%	14.0x	CNI	$14.3B
Data	10%	19.4x	DLR	$10.2B
BIP	$3.4B	14.3x	BIP	$48.5B

Click to enlarge

Effectively what this shows is that a rough fair value EV/EBITDA multiple for BIP based on a sum-of-its-parts analysis is 14.3x. However, in reality, BIP currently trades for a 19.5x EV/EBITDA multiple, indicating that the valuation multiple that Mr. Market is applying to its underlying businesses is much higher than what they are currently selling for on their own in the public markets today. As a result – as long as it continues to benefit from this bullish sentiment from Mr. Market – by simply buying businesses at close to their publicly traded value, BIP generally can create significant value for its equity investors.

Investor Takeaway

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

BIP/BIPC continues to generate solid growth alongside a decent current yield. With that said, however, we do not find it to be particularly cheap at the moment and believe that EPD offers investors better risk-reward. It is true that BIP/BIPC derives a lot of its value from the superior access to deal flow and capital from its Brookfield parent that management skillfully leverages to drive strong growth rates over time. As a result, we do believe that BIP/BIPC deserves a valuation premium.

However, as we 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 businesses that specialize in those specific industries. We think that there is certainly no margin of safety built into the current valuation and a case can even be made that the stock is overvalued right now. As a result, we rate BIP/BIPC as a Hold and EPD as a Buy and hold it as a key component 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 U.S. exchange. Please be aware of the risks associated with these stocks.