Description

Macquarie Infrastructure Corp

Summary

Macquarie Infrastructure has been written up on VIC three times, in 2010, 2012 and 2014.  It has been an outstanding performer generally, but has stagnated lately and indeed fallen quite a bit since it ran up to nearly $90 a share in early 2015.  The story is pretty straightforward though.  

MIC owns a collection of high free cash flow businesses run by a management team that has a solid track record of growing EBITDA, FCF and their dividend quite steadily since 2012.  In fact, FCF per share has grown on a CAGR basis by 16% over the past 5 years (2012 to 2017).  The dividend has grown from 20c/quarter in 2012 to today’s level of $1.38, and is guided to grow by another 10% this year and next.  

Given the malaise in the stock, you can now pick up shares at a 9% FCF yield on 2018 figures, and can clip a hefty 7.6% dividend while you wait for the market to wake up to the stock’s undervaluation.  That is about the highest dividend yield it has ever traded.  On an EBITDA basis, MIC is trading at only 11.3x 2018 EBITDA, a huge discount to Brookfield Infrastructure (BIP) at 17x forward EBITDA.

Business

Prior write up’s did a good job of describing MIC’s business lines but here is a quick updated summary below:

1. IMTT.  The company’s biggest segment at 45% of EBITDA.  MIC operates 10 bulk marine storage terminals (mostly refined oil products) and 2 in Canada.  The biggest terminal is their Bayonne NJ facility in the NY Harbor which is roughly â…“ of their segment EBITDA.  Half of their segment EBITDA comes from their 4 terminals in Louisiana.  These typically run 94% utilized, have contracts in place for 2.3 years today and tend to be hard to replicate assets.  Overall 80% of EBITDA is fixed price contracts (with inflation type escalators).  Customers include major oil companies and refiners, and 7 of the top 10 are investment grade rated.  Greenfield storage is expensive to build today, and MIC has been in this business since 2006. These are marine terminals too, so shoreline access is severely limited.  In July 2014, MIC purchased the 50% of IMTT that it did not own from the Coleman family at 10.7x EBITDA, well known for their lackluster management and poor capital allocation skills.  Demand for storage overall continues to be strong and management has indicated that pricing also remains firm, with new contracts typically getting done at higher prices.  Below you can see the margin improvement since MIC took control of IMTT in mid 2014:

2. Atlantic Aviation.  MIC leases hangars and fuel handling facilities from airport authorities at 72 airports around the US.  AA is around 33% of consolidated EBITDA today.  This business has faced scrutiny in the past, as the business is cyclical and Atlantic Aviation used to be quite heavily levered.  Today though, flight takeoff/landing data support solid organic growth (around 3% in the September quarter, see this link: http://aspm.faa.gov/apmd/sys/bjpdf/b-jet-201709.pdf).  Leverage is now quite low with Debt/EBITDA at only 2.3x today.  Like all of the businesses that MIC management runs, Atlantic Aviation is a high FCF/margin business.  Even though it is cyclical, the LT health of AA appears solid.  Even in the depths of 2009, EBITDA only fell about 22% from its peak levels.

3. Contracted Power & Energy (CP&E).  This segment is consists of a renewables business (6 solar facilities and 2 wind facilities), plus the BEC power plant in Bayonne NJ (BEC=Bayonne Energy Center).  The renewables assets are contracted out for 15-20 years to highly rated counterparties who pay a fixed price for all of the power output produced.  Volume is the only variable here, as poor wind conditions or less sun can impact Megawatts produced.  The BEC facility is a newly refurbished natgas fired power plant that is 62.5% tolled and serves the NYC area.  There is volatility with the merchant power production, and cool summer weather did have an impact on power demand this year.  

4. Hawaii Gas.  A stable monopoly gas distribution business in operation since 1904.  It is pretty small in the grand scheme of things, but fits into the MIC mandate of generating lots of stable free cash year in and year out.  

Here is a summary of EBITDA on a proportionate basis.  Since the July 2014 acquisition of 50% of IMTT, there is only about $8mm of minority interest per year, cleaning up the story quite a bit from the old days.

Issues

There seem to be several issues overhanging the stock this year worth discussing.  

1. Fees.  The knock on Macquarie mostly are the huge performance based fees that the company occasionally pays out to its external managers.  The base management fees today run about 75mm/year, paid in stock.  The performance fees are paid quarterly based on the performance of MIC stock vs the MSCI US Utilities Index (management gets 20% of MIC’s returns over the index).  The good news today is that given MIC’s poor performance since mid 2015, the high water mark on the stock is almost $100 per share now.  The math is straightforward.  The Utility index is up 39% since 7/1/2015, vs MIC up 2.3% inclusive of dividends.  So MIC has 37% upside (to $99.30 per share) before any performance fees will be docked from investors.  The base fee here doesn’t bother me, and for the record while management excludes all external management fees from its FCF calculation, I include it below.

2. New capacity in Louisiana threatening IMTT’s business there.  Yes, half of IMTT’s EBITDA is from LA, and there are construction plans to potentially add 10mm barrels of incremental storage capacity.  Even if all 10 is built, that 10mm would not hit until 2020 at the earliest.  Air permits likely will limit capacity to 3mm barrels.  That is really a drop in the bucket compared to the 21mm barrels of storage that IMTT already has in Louisiana.  Looked at differently, in the past decade, storage capacity in Louisiana has grown by 50%, and so far pricing for refined product storage generally has remained strong.

3. Correlation of MIC stock to the MLP universe.  Unfortunately, MIC is 80% correlated to the AMLP index.  I recently read that energy is the lowest percentage of value in the S&P500 since 2002 or something.  I’m not sure why midstream service providers are so cheap (I still own a ton of CEQP written up here a couple years ago), but they are value trap type names right now.  Eventually the market will wake up, but I’m not sure if its in 2017 or 2020.  At least I’m collecting big dividends to wait.

4. NOL’s running out.  MIC has $398mm of NOLs (as of 12/31/16), and expects to use 95mm this year.  They are likely to run out so that in 2020, MIC could be faced with corporate taxes.  However, back in 2010, they had NOL’s that were expected to run out in 2013, and yet still management has managed to create tax losses to avoid corporate taxation.  Growth capex, stepping up the book value of acquired assets, and favorable tax treatment from renewables projects will likely extend their nearly tax free empire for years.

5. Premium valuation to the sum of the parts.  Here is my math on the topic:

I think these are conservative numbers, so one may ask why pay more than this?  Fair enough, but this isn’t a liquidation.  At some point investors should consider this in light of Brookfield BIP which trades at 20x 2017 EBITDA, and 17x next year.  BIP no doubt has a halo around it, rightly so.  They are growing 20% too, and MIC intends to grow FCF by 10% per year.  But a valuation closer to 15x (where the bigger energy infrastructure corporations trade) seems a lot more logical.  

Bigger energy infrastructure corporations are the best comps.  That would include names like OKE, and WMB and KMI.  These trade at 14x, 15x and 14x EBITDA respectively, and 4%, 5.3% and 2.7% dividend yields.  KMI is trading around a 10% FCF yield, but has limited growth and continues to pay down debt.

15x EBITDA on MIC would put the stock at $95, and at a 5.8% dividend yield.  With dividends, that is upside of 38% in a year.

6) Technical overhang.  There continues to be a transition of ownership here out of hedge fund hands (from a 40% peak to 11% today).  There are also 1.7mm shares that were issued in August to fund the Epic Midstream acquisition that management seems to think have also been weighing.  I don't know really, and unfortunately management doesn’t seem likely to implement a share buyback plan.  But on the other hand, insiders own nearly 6% of the equity and have huge incentives to get the stock back above $100 per share.

At one point, management was $4BB in the hole in terms of a high water mark (probably in 2009 or 2010 I assume).  They seem confident that in the future the stock will catch up to its earnings growth.

Free Cash Flow

So, while management publishes FCF excluding base management fees, below I include them to get to what I deem to be real economic FCF on a per share basis.  The numbers are pretty impressive over the past 5 years, even with some $400mm paid to management in performance fees in 2014 and 2015.

Note that EBITDA in 2012 through 2014 was net of the 50% of IMTT that they did not own.  To me it is quite evident that FCF/share growth has been impressive.  Also of note, total EBITDA has grown by $419mm from 2012 to 2017 (inflation adjusted).  In that time, management has $2.7BB of growth and acquisition capex.  While clearly an imperfect, rough-cut analysis, it does indicate to me that their mix of growth capex and acquisition capex has added EBITDA at a 6.5x multiple.  

On that front, they do typically acquire business around a 10% ROE.  CP&E acquisitions will be high single digits (less risk in solar/wind projects), and Atlantic Aviation deals will run in the 14-16% range, and IMTT deal somewhere in the middle.  (They just paid 11x EBITDA for Epic Midstream, which is mostly jet fuel storage).  Speaking to the company and listening to their calls should give investors comfort that these are guys sophisticated at allocating capital.  

I have no quibbles with maintenance capex figures here.  Storage tanks require little to no maintenance (cleaning and inspections are expensed too).  Atlantic Aviation also needs little infrastructure apart from pumps and a steel hangar.  

Conclusion

Probably the downside is mid 60s on the stock, or a 10% FCF yield on 2018 numbers, that is, barring a recession.  With FCF per share approaching $6.49 next year (I frankly just took street estimates for 818mm of EBITDA, but quick math suggest that $600mm in capex at 10x would add 60mm in EBITDA and guided SG&A cuts will help by another $15mm, gets near that).  

I don’t see a major catalyst, but if dividends go up to $6.11 next year, my estimate, then at $72.50 MIC would yield 8.4%.  That is getting to pound the table type levels in my opinion.  At some point valuations matter, and my target of $95 doesnt seem crazy given peer valuations and expected growth.

Catalyst

dividend increases, continued growth, seller overhang done