Regarding your column last week, I am puzzled why Brookfield Infrastructure Partners LP (BIP.UN) would be a good investment when it has a price-to-earnings multiple of 50. Please advise. Thank you.
Before I answer the question, a request to readers: If you’d like me to explain valuation or other financial figures for a particular company, please include the source of your data. Better yet, e-mail me a screenshot. There are myriad sources of financial ratios online, and readers often send me numbers without indicating where they got them. The more information I have, the easier it will be to answer your question.
Now, since I don’t know the source of the P/E multiple of 50, I can’t tell you how it was calculated. What I can tell you is that it’s often dangerous to rely on data published by financial websites. These numbers are typically crunched by a machine, often with little regard for the nuances that apply to specific companies and industries.
That’s why we still need the input and expertise of human beings.
In Brookfield Infrastructure Partners’ case, most analysts pay attention to a cash flow measure called funds from operations (FFO). The company defines FFO as net income excluding non-cash items such as depreciation and amortization, deferred income taxes and other items “that are not related to the revenue earning activities and are not normal, recurring cash operating expenses necessary for business operations.”
The advantage of using FFO is that it focuses on the cash generated by the business, as opposed to accounting earnings that include non-cash items that don’t affect the company’s ability to pay distributions. Certainly, the Brookfield empire has come under plenty of criticism for its complex structure and accounting, but suffice to say that most analysts accept FFO as a legitimate measure to evaluate the business.
Now, back to the P/E ratio. Analysts expect Brookfield Infrastructure Partners – which reports in U.S. dollars – to generate FFO of about US$2.95 per unit in 2023, rising to about US$3.25 in 2024. On Friday, the units traded at about US$27 on the New York Stock Exchange (where the ticker symbol is BIP). If we plug the NYSE market price into the P/E’s numerator, and substitute FFO estimates for the “E” in the denominator, we get P/FFO values of 9.2 and 8.3, respectively, for 2023 and 2024.
In other words, investors are willing to pay about eight or nine times cash flow, as measured by FFO. That’s actually a pretty reasonable multiple.
Generally, companies with strong expected earnings and cash flow growth command high P/E (or P/FFO) multiples, while those with slower expected growth trade at lower multiples. The most attractive companies, from an investing standpoint, offer the best of both worlds: strong earnings growth and a low or modest multiple.
Brookfield Infrastructure Partners ticks both those boxes, according to many analysts.
The partnership’s current valuation is “a drastic discount to its 5-year average P/FFO multiple” of 12.5, said Frederic Bastien, an analyst with Raymond James, in a recent note. In light of the discount, Mr. Bastien rates the units a “strong buy,” with a price target of US$40 ($54.50). That compares with the average price target of US$37.50 ($51.10), according to Refinitiv, representing a premium of about 39 per cent to the current market price. Analysts’ price targets are often overly optimistic, but even if the units were to get halfway to the target it would represent a very attractive return.
The lesson here: If you had taken the P/E of 50 at face value, you wouldn’t know the units are trading at an attractive valuation.
One final note: When calculating a P/E, P/FFO or any other financial ratio, be careful not to mix currencies. If I had used Brookfield Infrastructure Partners’ price on the Toronto Stock Exchange, I would have had to convert it to U.S. dollars to match the currency in which Brookfield Infrastructure reports results. If the currencies don’t match, the ratio will be meaningless. I’ve seen some financial websites, and even discount brokers, make this mistake, which is another reason to double-check any numbers you find online.
I enjoyed your column about Brookfield Infrastructure Partners LP and its related company Brookfield Infrastructure Corp. But maybe your readers would like to know more about their differences and how they pay dividends in helping to decide which one to own. I know I would.
Brookfield Infrastructure Partners LP (BIP.UN) is a limited partnership that receives investment income – including dividends, interest and return of capital – from subsidiary companies. These companies operate infrastructure assets such as toll roads, data centres, utilities and communications towers.
Reflecting the LP structure, the partnership’s distributions typically include a mix of Canadian interest, foreign interest and dividends, return of capital and other income. To eliminate headaches at tax time, I hold the partnership units in a registered account.
Brookfield Infrastructure Corp. on the other hand, uses a traditional corporate structure, which allows it to pay dividends that qualify for the Canadian dividend tax credit. That makes BIPC suitable for non-registered accounts, although it is perfectly acceptable to hold the shares in a registered account.
Another key difference between BIP.UN and BIPC is their yields. Although BIP.UN and BIPC pay exactly the same distribution/dividend of US$1.53 annually, BIP.UN’s units trade at a lower price than BIPC’s shares, perhaps reflecting broader investor interest in the latter’s corporate structure and favourably taxed dividends. As a result, BIP.UN has a higher yield of about 5.6 per cent, compared with BIPC’s yield of about 4.8 per cent.
I know someone is going to ask me which security is the better bet. The answer is: I don’t know. The price gap between the two has widened and narrowed over the past few years, and I expect that will continue. My solution to this dilemma is simple: I own both.
E-mail your questions to jheinzl@globeandmail.com.