Dodge the recession with essential infrastructure
Dodge the recession with essential infrastructure
Politicians and a few eternally optimistic property spruikers are about the only ones still pretending we’re not headed for recession. As increasingly dire unemployment numbers come out, more and more are joining me in the ‘it’s going to be bad’ camp. It is coming, and you need to be prepared.
So what to do? You could take your money and put it in the bank. But that won’t do much for you with deposit rates at less than 5%. You could buy Woolworths shares. Everyone needs food, right? Woolworths is indeed a wonderful business. But you’re unlikely to do much better than the bank by paying 20 times earnings for a business with limited growth potential. And you could do much worse.
It’s a perfect example of a defensive business that isn’t necessarily a defensive stock – simply because the price is so high. But there is one sector of the market offering up juicy potential returns for what are genuinely recession-proof investments. It’s called essential infrastructure and, like most investments that seem too good to be true, there are (mostly) good reasons for the seemingly low prices. It is, however, worth a look.
Assets we can’t live without
Essential infrastructure assets are those which are essential to the functioning of modern society. Examples include toll roads, airports, power stations, pipelines and ports. Due to their monopolistic nature, these assets tend to be regulated by their respective governments.
Regulated or unregulated, though, the cash flow from these assets tends to be highly predictable and relatively immune to the economic cycle. People need water and electricity even in the worst of times. But that hasn’t stopped the share prices of the listed players being pummelled over the past 12 months. In fact, some funds are close to insolvent, such as Babcock & Brown Power and Babcock & Brown Infrastructure (both have suspended distributions and are undertaking asset sales in order to keep the bankers at bay).
The reason is debt, and lots of it. Infrastructure funds were front and centre of the credit bubble of the past few years. Incredibly favourable borrowing terms enabled infrastructure funds and their inappropriately incentivised managers to pay exceptionally high prices for assets and to fund juicy but unsustainable distributions. Over the past five years, Macquarie Infrastructure Group returned $3.2bn to its owners – more than double the $1.6bn of cash flow it received from its underlying assets.
Ponzi scheme no more
Not only are the Ponzi-scheme days over, but several of the weaker players – mostly from the Babcock & Brown stable – are having trouble refinancing their debt. Those that can obtain funds are paying substantially higher margins. All of which explains why no one wants to touch infrastructure investments with a ten-foot barge pole.
Herein lies the potential opportunity. The underlying assets remain attractive – in fact they’ve become more attractive. With corporate profits disappearing faster than Bernie Madoff’s friends, the relative stability and certainty provided by essential infrastructure is a safe haven. And the alternatives are offering very little in the way of returns.
The ‘flight to safety’ has pushed government bond yields to extraordinarily low levels. Lend your money to the US government for the next 30 years and you’ll earn a return of 3% per annum; buy UK bonds and you’ll earn 4% over the same period; and the 15-year Australian government bond is priced to yield 4.3%.
Low long-term interest rates make essential infrastructure offering returns of 8% and 9% an attractive alternative. There are endless opportunities to invest in the sector in Australia, spread across a wide range of asset types and regulatory regimes. At one end of the spectrum, there are those that look reasonably priced and have minimal need to refinance debt, such as Macquarie Airports and Challenger Infrastructure Fund. And, at the other, there are those, such as Babcock & Brown Infrastructure (BBI), with pressing refinancing requirements, which are trading for a small fraction of their underlying asset value – but that asset value may not do you much good if the fund doesn’t survive.
Plenty of cash looking for a home
For those funds that desperately need to sell assets, there does seem to be an active market among unlisted funds. A recent article in Breaking Views highlighted some US$94bn sitting in infrastructure funds that’s yet to find a home. Late last year, QIC bought 50% of Powerco, a New Zealand power company, from BBI. BBI also sold 20% of its Euroports business to Antin Infrastructure Partners, and, in December, troubled Spanish construction group Sacyr Vallehermoso sold its toll road business to Citigroup’s infrastructure fund for €7.9bn. There are no guarantees. But for the reasons outlined earlier, there are buyers, which is more than can be said for most financial assets at the moment.
And not only have the assets become more attractive, but so have the funds. Until now, the likes of Macquarie and Babcock have made fortunes through their insidious management contracts, and no one else has made a cent. But plummeting share prices have forced managers to accept less. Some funds have completely internalised their management; others have dramatically cut fees and beefed up the independence of their boards; and the rest are moving in the right direction. Babcock & Brown Wind recently internalised its management and paid off its former manager, Babcock & Brown, to the tune of $40m – undoubtedly the best investment it’s made.
It’s a broad sector and, with complicated structures and frequent shuffling of assets, it’s not easy to analyse. So far, at The Intelligent Investor, we’ve got positive recommendations on Southern Cross SKIES (a security issued by Sydney Airport trading under the ASX code SAKHA) and BBI EPS (ASX code BEPPA) but they’re both income securities and suitable only for relatively sophisticated investors who understand such investments. But I’ll be spending a lot of 2009 prospecting for further opportunities. For those looking to sidestep the recession, it might pay to do the same.
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Do you also include power generation, agriculture and oil production as recession proof?
Are you suggesting that we buy 'recession proof' businesses now, and sell them when the econo my starts recovering?
As value investors, shouldn't we be looking to purchase 'recession proof' businesses during 'normal' market conditions, or even during bubble conditions, when they're more likely to be overlooked by others?
Power yes. As for agriculture and oil production, I'd say demand is reasonably recession proof but the economics of both are much more unpredictable than the type of assets I'm interested in.
Absolutely not Mars. In fact I'm in full agreement with you - the disparity in prices between recession proof businesses and cyclical businesses suggests you'll do much better buying the cyclicals now than you will the 'safe' businesses. Your dead right, the time to buy the Woolworths of the the world was 18 months ago, not today.
But I do think this particular sector has the potential to offer recession proof opportunities that are ALSO cheap. Anything with debt has been discarded and I'm not sure it's justified in all cases ... but sorting the wheat from the chaff is proving difficult.
Whilst your comments about the potential insolvency of BBI have some validity, it is a contradiction to then offer up BEPPA as a "positive recommendation" because it would suffer the same fate as BBI securities if the underlying company were to become insolvent. Your logic is flawed.
I.e. If BBI's "asset value may not do you much good if the fund doesn’t survive", the same is true for BEPPA.
conversely if BEPPA is a good buy, so is BBI
The BEPPAs rank in front of the ordinary shares in the event of default. This is a substantial difference. If the proceeds of liquidation are more than the senior debt, BEPPA holders get their full $1 before ordinary security holders get a cent.
If the business survives, the BEPPAs are going to convert into $1 worth of ordinary securities, which will severely dilute the existing owners. If the ordinary security price is 5 cents, BEPPA holders still get $1 worth (that's 20 securities), if its 20 cents they still get $1 worth and if its 50 cents they still get $1 worth. Plus the distributions on the BEPPAs are cumulative, so BEPPA ownders will get paid all their accrued interest before ordinary security holders get a cent.
You are right that if there aren't enough proceeds to cover the senior debt, both securities are worth nothing. But in almost all other scenarios the BEPPAs look a vastly superior investment to me given they are trading at similar prices.
On top of Steve's point, I'd add that just because a situation isn't 'safe', doesn't mean it won't make a good investment or that Steve¹s logic is flawed. Let's say you could pinpoint the risk of a complete wipeout of BEPPA holders over the next few years as being 40%, with a 10% chance of some impairment and a 50% chance of receiving $1-plus worth of value. In such an environment, the massive potential returns on offer for today's BEPPA may still make perfect sense for a small punt for many investors, although you'd never call it safe. And if you could find 10 similar but uncorrelated bets, total risk would fall dramatically. Risk versus reward still applies.
Hopefully we can also find some opportunities at the less-risky end, though, because BEPPAs certainly aren¹t for everyone.
Steve,
Looking at BBI's corporate debt maturity schedule gives a fair bit of optimism that BBI are not in as dire a predicament as the market would suggest. It's common knowledge part of all of Dalrymple Bay Coal Terminal is up for sale. No doubt there will be keen interest in this asset. These assets don't come up for sale very often. There is about 1.4B of non-recourse debt attached to DBCT. A sale price of 2.4B is not out of the question. This would provide about 1B worth of equity which could just about eliminate all corporate debt, at least all of it until December 2011. The remaining assets would generate free cash flow of approximately $200M, add in the savings in interest costs on the corporate debt of around $70M and you have a situation where BBI would have more than enough free cash to resume BEPPA interest payments and BBI distributions. Under that scenario, a BBI security price well in excess of the current price would be a formality. They have recently received above book value for Powerco and Euroports so it looks as though their book value is holding up well even in the worst possible climate. I see BBI and BEPPA at a multiple of the current price within a couple of years. Maybe both these securities are in the oversold boat. Your thoughts?
Steve,
Do you rate the chances of BBI surviving as very good, good, 50/50, unlikely or extremely unlikely?
infrastructure??? Look what happened to Asciano?
No company is "recession Proof"
Ah, because prices for oil and agriculture products fluctuate but power prices are regulated?
I just sold a parcel of TLS and bought more BEPPA. 10c in the dollar is a giveaway. It's pricing BBI for liquidation. If BBI survive, BEPPA are guaranteed to be worth $1(either in cash or BBI securities to the value of $1). Buying BEPPA at 10c is basically buying a call option on the BBI business.
There is 900% upside in BEPPA over 3 years. What are the chances of BBI being forced into liquidation in the next three years? Less than 40%? It's hard to put a figure on it but if we say BBI are 60/40 to survive, then BEPPA is a magnificent buy with 10 times upside. It's the equivalent of backing a cricket team at $10 when every bookie has them $2.50 (40%). You might not collect but you've certainly got value and that's all we can do. Keep buying value stocks. I have looked all through the BBI Investor Pack from October and for the life of me cannot see what the panic is all about. Sure, there are risks that the world might end but a sale of DBCT will just about ensure BBI's survival.
Steve must be still on holidays. Interesting that BBI have announced they will be negotiating an internalisation of the management agreement with BNB. Perhaps this is a pre-cursor to a name change?
BBI and BEPPA continue to be priced for liquidation. Can the market be that wrong? I hope not as I have just sold all my TLS and will be slowly accumulating more BBI/BEPPA over the next few weeks prior to the interim results being announced.
As Buffet says, be greedy when others are fearful. I cannot think of a better time to be buying these sound companies that have lost 95% of their value. Sure BBI has debt, but it looks more than manageable to me. The current market cap for BBI is less than what they got for 50% of one asset (Powerco).
Crazy but true.
Hi Peter. I own some BEPPAs myself, bought slightly above the current price, and think it's a good but risky opportunity. But I'm nowhere near as optimistic as you are.
Firstly, what seemed a manageable amount of debt 12 months ago is no longer what you'd call manageable - just ask GPT. I won't be comfortable until all the corporate debt is repaid and don't take much comfort from the repayment dates. There is some $1.4bn of goodwill on BBI's balance sheet which must be under review - any writedown could easily trigger a debt covenant.
Secondly, they seem to have a mountain of committed capex on top of the debt that needs to be funded, and I have no idea how much it is. Take a look at the Euroports announcement before Christmas - off the top of my head they sold a stake for some 120m euros but could only apply 30m of that to retire debt because they need to fund future expansion plans.
Thirdly, be careful on your free cash flow assumptions. The debt funding that's already in place was priced at absurdly low levels. Anything they can refinance now will cost them at least an extra 200 basis points - which will put a big hole in the cashflow available to equity.
Fourthly, they might have raised more than the current market cap through the Powerco sale but they didn't raise anything like the enterprise value - which is the important bit. There's $1.5bn of senior debt and some $800m in preference shares in front of the ordinary equity, so before the equity is worth anything you need the company's underlying infrastructure investments to be worth more than $2.3bn - comparing the market cap to the value of any one investment is irrelevant.
All up, I think there's a good enough chance of these assets being worth a lot to justify an investment - but if they came out tomorrow and said they're filing for receivership, I wouldn't fall of my chair. I've made my investment completely aware that there's a reasonable chance I lose the lot.
Steve,
On Powerco, they achieved 25% above book value which released AUD$320M after debt. Doesn't that imply a greater than EV sale price?
Regarding if they came out tomorrow and filed for receivership not making you "fall off your chair", I don't see anything in the ASX announcements over the last 6 months that resembles anything like Allco or Centro were saying. Unless Hamill and the Board are not telling the full picture, I can only go on what has been announced.
I’ll address your points individually:
“Firstly, what seemed a manageable amount of debt 12 months ago is no longer what you’d call manageable - just ask GPT. I won’t be comfortable until all the corporate debt is repaid and don’t take much comfort from the repayment dates. There is some $1.4bn of goodwill on BBI’s balance sheet which must be under review - any writedown could easily trigger a debt covenant.”
Any triggering of a debt covenant would be at the asset level on whatever asset was deemed to be impaired so as to trigger a debt covenant. Looking at the assets, where would there be impairment? Not at Powerco or Euroports as very recent sales have achieved EBITDA multiples that do not indicate impairment. NGPL? The company recently announced that it is performing to expectations? DBCT? I doubt it as the contracts are on a “take or pay” basis.
Secondly, they seem to have a mountain of committed capex on top of the debt that needs to be funded, and I have no idea how much it is. Take a look at the Euroports announcement before Christmas - off the top of my head they sold a stake for some 120m euros but could only apply 30m of that to retire debt because they need to fund future expansion plans.
You only spend capex where you see growth. Funding future expansion plans at Euroports doesn’t exactly sound like the assets are under-performing. I doubt BBI would be throwing capex dollars at assets for the sake of it. Capex would be spent on assets where growth is expected.
“Thirdly, be careful on your free cash flow assumptions. The debt funding that’s already in place was priced at absurdly low levels. Anything they can refinance now will cost them at least an extra 200 basis points - which will put a big hole in the cashflow available to equity”
Not so sure about a “big hole” in the cashflow. Remember interest rates have fallen and still are falling. An increase in say 200 basis points will likely be offset by a lower base rate.
“There’s $1.5bn of senior debt and some $800m in preference shares in front of the ordinary equity, so before the equity is worth anything you need the company’s underlying infrastructure investments to be worth more than $2.3bn - comparing the market cap to the value of any one investment is irrelevant.”
True and I also hold BEPPA for that reason.
I'll think you will also find that debt covenants cannot be triggered with a non-cash impairment like a write down of goodwill. Debt covenants at the asset level are based on cash flow /debt ratios.
I understand people's fear in this market. Every single negative is looked for by the media and analysts and any positives are glossed over. One senior analyst from a leading broker told BBI management that they had a "lazy" balance sheet in 2006 and needed to take on more debt to expand the business. That same analyst last year called BBI a "SELL" because of "debt concerns". Sure, the world has changed but I think it's fair to say a lot of analysts have "gone to water" on lots of stocks. I can name MCG as another stock where once bullish analysts have thrown in the white towel. They have lost their nerve and that's because of the market we are in.
I see this period as a tremendous opportunity for the investors who are prepared to be a bit brave and see through all the doom and gloom. I accept with BBI/BEPPA there are significant risks but whether those risks deserve a 95% haircut of the share price is very much up for debate.
I would have thought a 60% haircut would be more than sufficient but as usual, the market overshoots on the downside just like it did on the upside.
Glad to listen to the negatives though. It makes one do more research. Just on the bit Steve wrote about manageable debt levels RE: GPT. With all due respect to GPT, I don't think you can compare their assets to quality infrastructure assets that have 75% of their income regulated.
GPT is heavily exposed to possibly the worst sector of the economy. Commercial property prices will continue to be savaged throughout 2009 and possibly beyond. I'd rather own regulated gas and electricity assets than vacant commercial properties. I wouldn't touch GPT or anything involved in commercial property with a nine foot barge pole.
I understand an insto has been slowly dumping BEPPA. I bought another parcel today at 8.9c. If it trades under 7c, I'll be there boots and all. I'll be happy to sell my CBA shares and buy BEPPA at crazy give away prices. Yeah there's risk but life is a risk. 92% below face value will do me.
Incredibly, I was able to buy a nice parcel of BEPPA at 8c today. These exchangeable preference shares are only trading at a 1c premium to the BBI securities despite having over 3c worth of interest payments accrued and payable before BBI holders get anything and also being one step up the food chain just in case it all turns ugly.
These are the advantages brave buyers have when there are forced sellers (instos not wanting to hold and prepared to sell at any price) and few other buyers.
Steve,
You wrote "Fourthly, they might have raised more than the current market cap through the Powerco sale but they didn’t raise anything like the enterprise value - which is the important bit."
Please explain what you mean by this statement. They sold 50% of Powerco at 25% above book value.
Steve Johnson wrote: "There is some $1.4bn of goodwill on BBI’s balance sheet which must be under review - any writedown could easily trigger a debt covenant."
Any goodwill writedowns, IF they were made, would NOT trigger a debt covenant according to Jonathon Sellar (CFO of BBI). I spoke with him about other matters and whilst he couldn't comment specifically about certain matters, he did say that investors can choose to believe what analysts and journalists write or they can choose to believe what is written in the Investor Packs provided by BBI. There will be an updates Investor Pack released to the market on Wednesday, February 25.
Be careful with intangible assets on BBI financials. DBCT is held at (purchase cost - amortisation + capex). More confusing it is classed as an intangible asset, which distorts any simple NTA/debt calculation.
Yes you are spot on DBCT is worth in excess of $2 Billion and it is an intangible due to the asset being a long term leasehold.
I'll be very interested in looking at the interim results on Wednesday to see if there are any nasty surprises. If all is transparent and the gearing ratio still OK, I'll be exiting out of all my TLS and I'll just keep buying the BEPPA at around 8c in the dollar, maybe even cheaper as one insto is very keen to exit BEPPA along with their other investments. When clients ask for a redemption of cash, the instos have no choice but to exit, whatever the price. There's plenty of fear in the market. That's the time to buy.
Looks like BBI might have a hit a major snag with the regulatory approval process in NZ. Surely the NZ's wouldn't use a change of control clause to lower the prices BBI/QIC are going to be able to charge NZ consumers?
Once it comes out of the trading halt, I'll probably be able to buy BEPPA a lot cheaper one would think. This is a high risk stock with high rewards if a lot of things go their way.
or maybe QIC are screwing BBI on price given that the global credit crunch has worsened since the deal was signed in November?
Well QIC only gave BBI a trim rather than a short back and sides. I managed to buy a touch over 540,000 BEPPA (340+ on the opening and another 200 at 7.7c). This reminds me of AMP in the early 90's selling out of a tech stock I liked at 7c. A few of us got together and negotiated with AMP Funds Management to buy their entire stake at 7c. We sold about seven years later at $1.10. I'm glad my money is not tied up with fund managers who have no juice of their own on the table. It's easy selling stocks with no regard for price when you don't have part of the action personally.
Pretty solid result for BBI. Revenue and net cash flows holding up very well despite the global recession. Still plenty of hurdles to overcome but that's why they are 6c and not 60c. Risk/reward.
I bought some more BEPPA today. DBCT is about to undergo due diligence and a further stake in Euroports is up for sale. This will be slowly, slowly and all the more reason to hold BEPPA. The banks require a sweep facility now for reduction of corporate debt. This may pose a problem in 2012 regarding conversion of BEPPA. Long way to go though. Let's get through this deep global recession and if BBI are still around in 2012, BEPPA will be worth a bit of money.
This is a joyous day for me. Buying BEPPA at these prices gives me a really nice fuzzy feeling. I understand how some people have wobbly knees after paying higher prices but if you're confident about your research, then NOT buying is madness. The old saying is very true. "BE GREEDY WHEN OTHERS ARE FEARFUL". I'm ravenous and continue to sell a few blue chips to pay for these BEPPAs.
This has been a great day for value buyers. With this BBI/BEPPAstock, what is all the panic about? DEBT!
They haven't breached a single debt covenant.
Their corporate cover is 5 times (lock up is 2times).
Their assets are performing with EBITDA +5% on a like for like basis.
There are NO asset impairments therefore book values are conservative (remember these guys have never revalued any of their assets). Even good old DBCT is still in the books at the 2002 purchase price plus cap ex minus depreciation.
The gearing ratio overall has to come down but they are addressing that.
So because of simple fear and a couple of downgrades by two esteemed investment houses (Merryl "bail me out" Lynch and UBS), the market is allowing us to buy the headstock for under 5c and the prefs for 5c in the dollar.
That's a 20 bagger down the track.
Another one to look at is Macquarie Media. No corporate debt and NTA of $1.30 trading at 69c. Better not elaborate too much on a MAC stock on here though. They are supposedly toxic.
I avoided GPT with my nine foot barge pole. Even at 27c it's a riskier proposition than BEPPA by a country mile. As I said, GPT are in the worst part of the economy. One could easily see 40% impairments in commercial property, maybe a lot more?
Unfortunately, a lot of super funds are overweight GPT which will be a nightmare for those pending retirees who were relying on super. It's tragic really.
Steve,
You bought these around 13c I think you said. Now they under 5c are you taking advantage of the insto seller and buying more? Fundamentally nothing has changed so I'm still in there chipping away and picked up another parcel at 5c today.
Well even if Steve isn't buying anymore BEPPA (and I assume he's not due to the silence), I'm still loading up all bases with these. When the market is fearful, petrified, just attack. Identify true value and buy those stocks with your ears pinned back.
BNB going into administration might be the trigger for BBI to sever all ties, change the name etc.
I know the market is pricing BBI for oblivion but on what I see of the balance sheet, I still don't know what all the panic is about.
They do have to reduce debt but they are in the process of further asset sales. A sale of DBCT and PD Ports would eliminate corporate debt and BBI would then be out of the woods. BEPPA at 5c would be looking very juicy for a 20 bagger by 2012. I've sold blue chips to buy these "risky" BEPPAs. Risk/reward.
Some of the other infrastructure stocks also look oversold. APA, ENV, SKI, DUE all look to be bargains and priced on panic.
I've met with a few brokers/analysts here in Brisbane the last week. Collectively they don't instill much confidence in their ability. To a man, they are all advising "caution". Funny that. They weren't afraid to place BUY recommendations at the market peak yet now that prices are off 90% in a lot of cases, they are now saying "be careful". What credibility they had is lost I'm afraid.
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