CA - Brookfield Infrastructure Trade: The Switch That Gives You Extra Yield

2023-08-14 10:00:00 ET

Summary

• BEP and BIP are quality companies trading at good prices.
• Their preferred shares have very good yields and the FFO covers preferred dividends by about 10X.
• We think a switch is merited based on almost identical merits and a far superior entry point for one.

There was a time when one had to reach into deep junk to find 7% yields . That was a time for caution. While today's interest rates and bond markets still pose some big risks, at least you have one thing really going for you. You can get great yields all over the place. That said, people still don't seem to compare what is available and that leads to massive mispricing of some securities. Today, we are going to look at one example of market inefficiency that you can take advantage of.

Quality Company 1

Brookfield Renewable Partners L.P. ( BEP ) is one we have covered a few times in the past. For those unaware, here is a brief overview.

BEP is a global clean energy powerhouse that has delivered revenue, funds from operations ((FFO)) and distribution growth over the last decade.

Now when we say global, we do mean global.

Even within the clean energy segment, the company hardly restricts itself and continues to add projects across the spectrum.

If you want to own anything in the "boring utilities" segment, here is where you need to go.

On our last update, we felt that BEP was finally near a buy zone. This was after a lot of froth had come out from the stock. In the last year, we have only been able to assign Sell or Hold ratings.

Today, the stock remains close to a "buy" but we want to focus on its preferred shares.

Brookfield Renewable Partners L.P. 5.25% PFD CL A ( BEP.PA )

This is a fixed rate issue is NYSE traded and currently has a yield of 6.52% at a price of $20.52. These are perpetual issues but can be redeemed at par by BEP on or after March 31, 2025. BEP is rated BBB+ by S&P, but that applies to BEP debt. The preferred shares are rated BBB-.

While credit ratings are a good start, one needs to examine further. Here, we see that BEP's credit rating is further enhanced by very low corporate level debt (debt to capitalization of just 11%), high liquidity, long term fixed rate debt placement and primarily non-recourse overall debt.

BEP's FFO covers the preferred unit distributions more than 10-fold over.

The combined information gets us to one of the best preferred shares that you can find and on the surface, the 6.52% yield looks good.

Quality Company 2

Brookfield Infrastructure Partners L.P. ( BIP ) is another company from the Brookfield Asset Management ( BAM ) fold and it operates a diversified portfolio of assets that include utilities, transportation, midstream energy and data infrastructure.

Just like BEP, BIP has delivered price appreciation and dividend growth over time.

On the credit front, BIP is very similar to BEP. They both have identical BBB+ debt ratings from S&P and use the same non-recourse heavy debt structure.

Brookfield Infrastructure Partners L.P. 5.125 CL A PFD13 ( BIP.PA )

This fixed rate issue currently has a yield of 7.30% at a price of $17.57. These are perpetual unless redeemed at par by BIP on or after October 15, 2025. BIP.PA stands in the same commanding position relative to BIP as BEP.PA stands with BEP. The preferred distributions for BIP.PA are covered at about 10X and these preferred shares bear the same ratings of BBB- from S&P. So we are getting about the same quality when we buy BIP.PA as when we buy BEP.PA, but a far better yield.

Which Is Better?

While the two preferred issues mentioned are extremely similar and it is hard to pick a winner out of the two just on quality, we have to give an edge to BIP as far as the primary company is concerned. Sure, renewable assets get a lot of press, but BIP is diversified across 4 different assets that don't necessarily track each other during an economic cycle. They are also more consistent and predictable in their performance. These advantages are unlikely to trickle to the level of preferred shares, but there is no question that BIP is the better long term bet relative to BEP. So BIP.PA would get the edge over BEP.PA.

Of course, the great deal today is that you get BIP.PA at a 7.3% yield versus the 6.52% yield from BIP.PA.

Verdict

Sell BEP.PA and buy BIP.PA.

As the longer term paths show, they occasionally trade at the same yields. Late October 2022 was one example when BEP.PA and BIP.PA had the same yields. Today we have a high spread in favor of BIP.PA and that is bound to reverse over time. For the income investor this is a great place to tack on an extra 0.8% of yield and look to swap when BIP.PA yields less than BEP.PA. One final note here is that there is another BIP issue Brookfield Infrastructure Partners L.P. 5.00% PFD A 14 ( BIP.PB ) which has a 5% coupon versus the 5.125% for BIP.PA. This is identical to BIP.PA outside the small coupon difference. Investors can buy this in place of BIP.PA if it trades with a higher yield.

Tax Considerations

Both BEP.PA and BIP.PA/BIP.PB get you K-1s. But these are rather simple ones with no UBTI as both companies are Bermuda based partnerships. For more details visit BEP and BIP tax pages.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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