JamesBrey
Back on December 23, 2022, we purchased a large position in Brookfield Infrastructure Partners’ (NYSE:BIP)(NYSE:BIPC) preferred units (NYSE:BIP.PR.A) at a price of $16.63 per unit. However, we recently sold our position at $18.70 per unit, locking in a nice 22.1% total return (17.3% annualized) including distributions and in this article, we detail why.
BIP/BIPC Overview
Last October, we bought the dip in BIP units when it was trading in the low $20s and have made a hefty profit off of it since then. Shortly after buying our position, we wrote a deep-dive piece that responded to some other criticisms that were being levied at BIP/BIPC at the time. In short, the criticisms we addressed were:
- BIP is way overvalued
- BIP is overpaying its distribution
- BIP is not actually creating unitholder value
You can read the article that we linked to above if you would like to read our detailed responses to these assertions, but the good news is that none of these problems really impact the preferred units, so regardless of whether you agree with our view on BIP/BIPC or not, the preferreds should be viewed as being fairly safe income investments, because:
- BIP has a strong balance sheet as evidenced by its BBB+ credit rating, its relatively low corporate-level debt (with the remainder being non-recourse asset-level debt), the fact that 90% of its debt has a fixed interest rate, its average term to maturity of seven years, the fact that only 5% of its debt is maturing over the next 12 months, and the fact that it has $2.8 billion of available liquidity. This means that there is a fairly low risk of it experiencing enough financial distress to threaten its preferred.
- Brookfield likes to use preferred equity to fund growth investments, so maintaining the sanctity of its preferred distributions and treating preferred unitholders right is essential to being able to continue to command a reasonably attractive price for issuing preferred equity.
- BIP has a very diversified portfolio of relatively defensive assets with strong counterparties and lengthy contract terms.
- BIP also continues to grow cash flows per unit at a brisk pace, which also provides additional coverage for the BIP preferreds.
Why We Sold BIP.PR.A
BIP/BIPC remains a solid diversified infrastructure business that is well-managed and has attractive long-term growth potential. Moreover, Brookfield is an exceptional infrastructure operator and investor, enabling it to consistently generate attractive returns on investment and run a fairly aggressive capital recycling operation that further accelerates the compounding process. BIP also offers a pretty attractive current yield. As a result, we are long the common equity, albeit with a fairly modest-sized position.
However, we are no longer long the preferred equity despite previously having a very large position. The reason behind this is entirely due to its valuation, as when we sold it, its yield was under 7% at a time when the Federal Funds rate was less than 150 basis points lower. While it is true that a Fed rate cut remains the likely scenario at some point this year, the spread between an effectively perpetual preferred equity and risk-free short-term cash had gotten far too narrow to justify us continuing to hold this investment.
This is particularly true given that there are several other similarly high-quality preferreds (such as Brookfield Renewable Preferreds (BEP.PR.A)) and bonds that yielded well over 7% when we placed this trade and there are also several high-quality and conservatively covered common equities that offer similar or even higher dividend yields than BIP.PR.A, and these common equities are also growing their payouts at rates that exceed inflation (e.g., Enterprise Products Partners (EPD) and Enbridge (ENB)).
As a result, it simply no longer made sense for us from a risk-reward perspective to continue holding BIP.PR.A, though we would certainly be happy to buy back in on any future dips.
Investor Takeaway
We remain bullish on BIP/BIPC and rate it a Buy at the moment. Moreover, we own a relatively small-sized position in BIP units and would gladly upsize that position further to a large position should it dip back into the mid to low $20s like we did last October. However, we are much less bullish on the series A preferreds given that their yield under 7% is simply not compelling enough for a long-dated fixed-income preferred security relative to where interest rates are elsewhere in the market. Still, we like the quality of the business and think these preferreds – as a fairly small part of BIP’s capital stack – offer pretty safe passive income, so on any future dips back into the $17 or below range, we would be happy buyers of the series A preferreds.
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.
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