CA - Brookfield Infrastructure: Learn To Avoid Unreasonable Pessimism Next Time

2023-12-24 13:30:00 ET

Summary

• Brookfield Infrastructure is a global infrastructure-focused player with a well-diversified portfolio and predictable cash flows.
• Management expects to maintain distribution growth and has a solid plan for asset sales and debt repayment.
• BIP experienced a significant decline before bottoming out in October. It has since recovered all its October losses and more over the past two months.
• BIP's valuation dislocation at its October lows and still solid fundamentals suggested unreasonable pessimism as weak holders capitulated.
• Its surge since then has likely given investors an invaluable lesson about not falling prey to the market's move to force holders out at long-term lows in the future.

Brookfield Infrastructure ( BIP ) ( BIPC ) is a high-quality global infrastructure-focused player. Its assets portfolio generates " contracted and regulated revenues," providing holders with "predictable and stable cash flows." It's structured as an LP for holders choosing to invest in BIP or as a corporation for investors choosing to invest in BIPC. Brookfield Infrastructure is affiliated with the Brookfield family ( BN ) ( BAM ), benefiting from the scale and expertise associated with the leading asset manager.

Its infrastructure portfolio is well-diversified. FFO generation is mainly attributed to its utilities and transport segment. These two segments accounted for about 65% (before corporate adjustments) of Brookfield Infrastructure's FFO for Q3. Brookfield Infrastructure's midstream and data segments comprised the remainder of its FFO generated in Q3.

As a result, the hammering that BIP received since it topped out in April 2022 was likely attributed to the significant interest rate hikes by the Fed. Accordingly, BIP fell more than 50% from its 2022 highs toward its October 2023 lows to levels not seen since its COVID plunge.

However, dip-buying action returned aggressively as BIP bottomed out in October, recovering all its losses in October and more. Based on BIP's price action and valuation, I'm confident enough to suggest that we have likely seen the worst in its cyclical lows.

I've been bullish on utilities stocks over the past few months. I urged investors to capitalize on sector leader NextEra Energy ( NEE ) stock's steep decline in October amid the surge in long-term yields. I also encouraged investors to gain exposure to the utities sector ( XLU ) in early December if they have not done so. However, it should be noted that I added XLU to my portfolio for the first time on October 13, as I also informed members of my service about the incredible opportunity presented.

Therefore, I'm not surprised about BIP's significant reversal, as it rose from peak pessimism. One of the biggest challenges investors must overcome is avoiding falling prey to peak pessimism and optimism. Recognizing signals through assessing valuations and price action is critical to deriving helpful insights and making the right decision. BIP's peak pessimism was easily observed as its forward AFFO per share multiple fell to 8.77x at its October lows, well below its 10Y average of 14x.

Hence, it should have alerted bearish investors that if they decided to sell, it could be the worst possible time to sell with BIP at a possible long-term low, given the deviation from its long-term average. Investors need to question whether the underlying fundamentals in BIP have changed so dramatically that necessitated such a de-rating. Or was it an astute move by the market makers forcing a capitulation as BIP fell toward its COVID lows, compelling investors to exit as they feared the worst was yet to come?

Given the steep recovery as BIP recovered all its October losses and more over the past two months, let's be honest with ourselves. Have BIP's fundamentals changed so much that the market was foolish? No, the market is always right, but the market makers managed to force a well-timed capitulation, in line with the peak in the 10Y ( US10Y ) as it broke above the 5% mark in October, stunning investors.

Brookfield Infrastructure still expects to maintain its long-term distribution growth of 5% to 9% based on its Q3 earnings call update. Management doesn't expect a deviation from its asset recycling strategies in 2024, anticipating a further $2B in asset sales, "which is considered an actionable plan." As a result, it is expected to bolster its pro-forma liquidity to $4B, providing more confidence to investors about its ability to invest for growth.

Management also updated that it doesn't anticipate significant stress on debt repayment in 2024, with just 5% of its debt maturing over the next twelve months. Moreover, 90% of its debt profile consists of "locked-in interest rates, with an average maturity of around seven years." As a result, it should assure investors about Brookfield Infrastructure's ability to meet its forward distribution. Furthermore, Brookfield Infrastructure still expects to meet its targeted FFO payout ratio between 60% and 70%. Therefore, I didn't assess imminent risks on income investors presented with a highly attractive forward yield that nearly reached 7.5% at its October lows. With BIP still assigned a robust "A-" growth grade relative advantage over its sector peers, the valuation dislocation over a growth and income stock didn't make much sense. Consequently, I concur with management's emphasis that "Brookfield Infrastructure is a long-term wealth compounder, providing dividend and growth assurance to investors."

With that in mind, assessing whether investors should consider waiting for a pullback or adding more at the current levels is timely. It's a pertinent question after a recovery that exceeded 50% in price-performance terms since its October lows.

Moreover, It has lifted its 5Y total return CAGR back to 14.4% with the recent surge, above its 10Y total return CAGR of 13.1%. In other words, some caution might be in store for a possible pullback as its valuation dislocation has normalized, in line with Seeking Alpha Quant's "C+" valuation grade. Therefore, I believe it's reasonable for investors to consider waiting on the sidelines for another opportunity to add at its subsequent pullback.

Takeaway

Brookfield Infrastructure is a high-quality infra play that has consistently delivered for investors over the past ten years. It's a total return wealth compounder, as underscored by management. Its focus on driving a sustainable 5% to 9% distribution growth hasn't changed, notwithstanding the recent market upheavals. Bolstered by a reasonable FFO payout ratio that didn't seem to be in danger of suggesting a distribution cut, holders who sold at BIP's October lows likely learned an important lesson about getting forced out from an astute capitulation move by Mr. Market.

Rating: Initiate Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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