FA Alpha Daily

This utility company is much riskier than rating agencies think

Utility companies are typically considered safe and resilient during economic downturns, although, they may overleverage their balance sheets if they invest heavily in their assets to increase profits. An example of this is Brookfield Infrastructure Partners, the company has focused on owning assets resulting in them being overleveraged yet rating agencies still consider this company safe. In today’s FA Alpha, we will evaluate Brookfield Infrastructure Partners using Uniform Accounting to see its true profitability and determine its actual risk level.

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As opposed to how it’s widely known, utility companies do not make money by actually selling and distributing electricity or gas to their customers.

They make money by investing in infrastructure or assets, like pipes and wires, that provide public utility services to customers.

Hence, their profitability depends on the size of their asset base and their allowed rate of return from their respective regulators called Public Utility Commissions (PUCs). 

In order to increase their profits, these companies are focusing and spending a lot to expand their asset base as they already have a set rate of return from PUCs. 

That is why these companies usually make unnecessary investments just to increase their asset base, which therefore increases their profits.

But while doing so, they’re significantly relying on debt and overleveraging their balance sheet. This is exactly what is going on with Brookfield Infrastructure Partners (BIP) in the last few years.

The company has focused so much on owning assets that made them overleveraged.

The company’s investments in electrical transmission, natural gas pipeline, and cell phone and data transmission, are all highly asset-intensive.

It views them as “toll-taking opportunities” and generally they’re good businesses, but all of them are economically sensitive.

Meaning that if things slow down, that leverage will come back to get them.

However, rating agencies like Moody’s think that all is good in the utility world and do not consider unnecessary investments the company has been making in the last few years.  

Moody’s is rating the company like it has no risk of default.

We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand the company’s obligations matched against its cash and cash flows.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

The CCFP chart clearly shows that Brookfield Infrastructure Partners’ cash flows are not sufficient to cover its obligations going forward.

CCFP chart indicates that the company has significant debt maturities in each of the next 5 years going forward.

As they relied highly on debt and overleveraged their balance sheet, its cash flows are currently not enough to pay down that debt.

In addition, a possible downturn in the near future might lead to a significant crisis as they heavily invested in asset-intensive and economically sensitive businesses.

Taking these factors into account, Brookfield Infrastructure does not seem that safe at all. This is why we think that there’s a significant risk of default for the company and we rate it “HY2”.

This rating places the company in the high-yield basket, as opposed to Moody’s recommendation of investment grade.

It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.

To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.

SUMMARY and Brookfield Infrastructure Partners (BIP:USA) Tearsheet

As the Uniform Accounting tearsheet for Brookfield Infrastructure Partners (BIP:USA) highlights, the Uniform P/E trades at 16.8x, which is below the global corporate average of 18.4x and its historical P/E of 22.1x.

Low P/Es require low EPS growth to sustain them. In the case of Brookfield Infrastructure, the company has recently shown a 81% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Brookfield Infrastructure’s Wall Street analyst-driven forecast is for a -698% and 18% EPS growth in 2022 and 2023, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Brookfield Infrastructure’s $33 stock price. These are often referred to as market embedded expectations.

Furthermore, the company’s earning power in 2021 was 2x the long-run corporate average. Moreover, cash flows and cash on hand are below its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 210bps above the risk-free rate.

Overall, this signals a high dividend risk and a moderate credit risk.

Lastly, Brookfield Infrastructure’s Uniform earnings growth is below its peer averages and is trading below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

This analysis of Brookfield Infrastructure Partners (BIP:USA) credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.

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