Description

Cheap on an absolute basis and relative to peers.

·    Trading at 2.1x management’s 2010 EBITDA projection (once the power plant is operational, and excluding the new concession the company won this quarter in Sao Paulo state) and 2.8x management’s 2009 EBITDA projection (with no income from the power plant). Annualizing the Q3 runrate free cash flow (excluding investment in new projects, which will yield cash flow in subsequent years) provides a free cash flow yield of more than 50%.

·    See Valuation for overview, but on a sum-of-parts basis, the stock should trade close to R$7, with the potential to trade even higher over a long-term period. With little risk to the EBITDA forecast, even bear-market multiples yield a valuation of R$4 closer to R$11, which would make it close to a double from the current price.

Has all the elements of a classic value investment

·    We first met management pre-IPO in the summer of 2007, and were impressed by the assets, but found the valuation rich. Stocks in the Brazilian tollroad sector got crushed in early 2008 as the round of tollroad concessions offered by the Sao Paulo state government prompted irrational price competition (OHL in particular was very aggressive, though their management argues that they simply did a better job of measuring the roads’ traffic than was reflected in the government data), leading to fears that the much-hyped future growth in this key infrastructure segment was not going to be rosy. The good news is that TPI management has been very disciplined and conservative in their bids, because they have plenty of other opportunities to deploy capital profitably (e.g., ports, power) (new projects are obviously on hold at the present time, but not relevant to the investment thesis at the current price).

·    The market is focused on the stream of earnings from tollroads, while the ramp-up in the port’s earnings means that the full-year impact of port-related EBITDA has not been fully realized (especially given the complete absence of sell-side coverage). The real number to look at is 2010, when the power plant becomes operational (especially since the balance sheet has already been penalized for the equity portion of the power plant capex).

·    After 2010, barring any new projects, the company faces a significant capex cliff as investment in new projects falls off and the relatively low level of maintenance capex allows the company’s substantial free cash flow generation to accumulate on the balance sheet.

·    The stock has suffered disproportionately in the emerging market selloff of the past year as its relatively small market cap, limited trading volume, concentrated ownership, and lack of sell-side coverage created unfavorable technical dynamics.

·    The sponsor group and majority shareholder of TPI announced early in Q4 their intention to acquire 1.5MM shares on the open market – a bullish sign of confidence in the company’s prospects.

·    Concer: 180km, three toll stations; in Rio de Janeiro state; links Rio de Janeiro to neighboring major industrial region and to nearby mountains, attracting mix of leisure and industrial traffic. 62.5% stake, concession from 1995-2020, underwritten to unlevered IRR of 13%. YTD, traffic grew 7.4% with an effective tariff increase of 4.7%.

·    Concepa: 121km, three toll stations; in Rio Grande do Sul state at the very south of Brazil, bordering Uruguay; seasonal traffic b/c more of a leisure road to the country’s main beaches/vacation spot. 100% owned (30% was acquired from minority shareholder at the beginning of Q4 08), with a concession from 1997-2017, and underwritten to unlevered IRR of 23%. YTD, traffic has grown 11.6% with an effective tariff increase of 3.4%. An 8.3% increase in the toll was authorized in October 2008.

·    Econorte: 341km, three toll stations; in agricultural Parana state (22.6% of country’s soybean production), where 22.6% of Brazil’s soy production takes place, traffic driven by agricultural sector; also seasonal, but tied to harvest periods. 100% stake (purchased 50% w/ IPO proceeds at 4x EBITDA), concession from 1997-2021, underwritten to unlevered IRR of 17%. YTD, traffic has grown 11.1% with an effective tariff increase 10.6%. This road has faced several aggressive moves by the populist governor of Parana, who has tried to expropriate the road and, failing that, attempted to stop the collection of tolls; numerous regional and federal court proceedings have struck down the governor’s attempts (most recently earlier this month), while Lula does not appear to be sympathetic (given his attempts to attract international investment in Brazil’s infrastructure sector – more on this in Risks).

·    TPI has a 50% stake in Porto de Navegantes (“Portonave”), a private port in Santa Catarina state (in the south, near the border w/ Uruguay). It is adjacent to Porto de Itajai, an existing public (concessionary) port, which is Brazil’s second-largest port (12% of TEUs, behind Porto de Santos which is 38%), is highly congested (45-hour avg mooring time), inefficient, and higher-cost b/c of its unionized labor. Portonave also has an integrated cold-storage warehouse, which is a key competitive advantage.

·    The region has 2MM TEUs container throughput, growing at ~15%; is one of the main meat-producing/exporting regions in Brazil (mainly poultry). The port’s ramp-up was delayed initially because the final environmental license took a few months longer to obtain than expected, and the security certification required to export to the US (post-9/11) was only received in March. Currently have two mobile cranes and three fixed ship-to-shore crane in operation (two came online during Q3); another two fixed ship-to-shore cranes were ordered in May for EOY-2009 delivery. Initial forecast for 2008 was for 300K TEUs this year (full equipment only working for half year), with 173K TEUs handled through Q3 (and interrupted in late November by flooding that is discussed in Risks); management forecasts 450K TEUs in 2009, ramping up to 750K during 2010. Eventually, capacity can grow to 1.5MM TEUs.

·    Portonave is a joint venture with Mediterranean Shipping Corporation (MSC – world’s 2^nd largest container shipper) and is extremely strategic (confirmed by MSC’s main competitor in the Brazilian shipping lanes) to MSC’s growth ambitions in the region. While exact figures haven’t been provided yet, MSC is expected to use the majority of the port’s capacity, with the remainder being signed up with other shipping lines (four major shipping lines have signed on already, partially shifting their business from Porto de Itajai) – the full capacity of the terminal had been committed by Q2 of 2008.

·    As Brazil’s first private container terminal, Portonave is not required to use unionized labor (~1000 bps cost advantage) and isn’t subject to the high leasing costs (~1000 bps cost advantage) associated with public port concessions in Brazil. Partial unionization may be a risk, but is manageable – see Risks. Likewise, there is some outcry by the public ports to cancel the federal regulation that allowed for the creation of private ports, but we do not believe this will affect Portonave, which would be grandfathered in the unlikely event of a change in regulation.

·    Location is strategic from two standpoints: (1) it is located adjacent to Porto de Itajai, which is one of the key ports on the Brazil trading lanes (“every container line has to come here” – consultant); (2) unlike the existing Porto de Itajai, which is surrounded by the city, Portonave has open land behind it and is consequently able to expand significantly with plenty of parking, storage, etc..

·    “Contracts” in this business are basically agreements on the part of the port to allocate berthing space (according to a fixed schedule) to a shipping line; the customer is charged a fixed fee per box moved (empty boxes get half the rate of full boxes) and typically there is an additional 15% of revenue from other services. Portonave’s tariffs are in line with the market, despite being a superior facility.

Rio Verde hydropower plant: 35-year concession for a 108MW hydro plant.

·    Have a 16-year power purchase agreement with Votorantim (AAA credit) beginning Q1 2010. Construction has proceeded ahead of schedule, so expect to begin operations in Q4 2009, which gives them ~3 months of power sales at spot prices, which will add ~$30MM to the balance sheet.

·    Have bid guarantees to protect against construction cost escalation. In any case, have already done all the rock excavation, now just need to put the concrete in place, which has less risk of cost escalation. Plan had a 3% cost contingency, and management seems very comfortable that this is not a risk.

·    Measurements of water flow indicate that Rio Verde can do 116MW instead of the permitted 108MW (at no extra cost), so have applied to regulatory body for increase in permitted capacity – 7% increase in top line will all flow to the bottom line.

·    Earlier this quarter, TPI announced that it was the winning bidder on a new tollroad concession (Ayrton Senna/Carvalho Pinto Corridor) in Sao Paulo State. We have not yet received details on the bid and resultant impact on capex, but are comfortable – based on the management team’s track record and past assurances – that their underwriting was conservative and the concession should generate an attractive project IRR.

·    Four new smaller hydro projects…have been quietly acquiring the land for these.

·    A windpower project in northern Brazil (very small for now, but gets them a foothold).

Current stock price:                BRL$1.01 (USD$0.43)

Market cap:                             BRL$138.1MM (USD$59MM)

Net debt:                                  BRL$503.2MM (USD$261MM)

Enterprise value:                     BRL$641.3MM (USD$320MM)

Q3 2008 run-rate

EBITDA: R$46.6MM (3.4x annualized EV/EBITDA)

Maintenance FCF: R$18.5MM (53.6% annualized FCF yield)

YTD 2008 (note that Portonave ramped up dramatically between Q1 and Q3; Q4 will be an anomaly due to the flooding that has impaired Portonave’s operations for several weeks)

EBITDA: R$119.5MM

Maintenance FCF: R$32.1MM

2009E

EBITDA: R$230MM (2.8X EV/EBITDA)

Sum of parts

·    In late November, heavy rains and flooding in Santa Catalina state led to the temporary suspension of operations at Portonave due to heavy silting of the main access channel to the port. The government of Brazil has allocated funds to dredge the channel, and it is expected to be fully operational (with light operations ongoing in the interim) by mid-January. 

·    The company estimated a revenue impact of R$500K per day (or roughly R$20MM over the duration of the interruption). This is obviously a significant near-term hit to the company’s financials, but does not pose an ongoing threat and should not affect the company’s earnings power.

Cancellation of Portonave private port license

·    The public ports are up in arms over the issuance of private port licenses, as the private ports enjoy better structural economics (minimal unionization, no costly concession lease) and – in Portonave’s case, as the first one – are stealing significant market share away from the public ports.

·    The public ports are lobbying to have the private port licensing regulation pulled, but management feels utterly confident that their license is not at risk – they received it under a clear legal framework, and would have to be grandfathered in the unlikely event of a change in regulation. In addition, the Brazil gov’t is extremely eager to promote investment in the country’s infrastructure (especially since Brazil got an investment grade rating) and would be very unlikely to do anything that would endanger that investment. Lastly, Portonave has created a lot of jobs, and consequently has the municipal and state governments quite happy.

Parana State attempts to expropriate/shut down Econorte

·    The highly-populist governor of Parana State has been trying for several years to somehow expropriate the Econorte tollroad (the only asset in his state). The company has filed and won nine lawsuits blocking the governor’s attempts, and does not think the federal government (for the reasons mentioned above) would allow the judicial system to be breached. This issue creates scary headlines every few months, but the company invariably asks for and receives a favorable judgment from the country’s higher courts, which have been directed by Lula to act in the interests of private investors to keep the foreign investment gravy train chugging along.

·    The unions are clamoring to get a piece of the action at Portonave. According to management, the issue has been resolved with regard to on-shore labor, but the decision is still outstanding with regard to on-ship labor. The worst case is that they have to use unionized labor on the ships, and that will cost them 100-200bps of EBITDA margin…not meaningful at the current stock valuation.

Poor/unprofitable capital allocation decisions in the future

·    Management has a very strong track record to date and has demonstrated discipline in their bidding for all of the major tollroad concession bids of the past several years. Their handling of the Rio Verde power plant project also demonstrates their risk aversion (no speculative risk taken).

Future capex needs

·    Excluding the capex needs of the recent Sao Paolo tollroad concession, on which we have not yet received data, management expects capex of R$200MM in 2009, dropping to ~R$50MM in 2010 (maintenance capex plus some investment in Concepa as part of a potential renewal of that concession). R$137MM of the 2009 capex is related to Rio Verde and will be funded through the BNDS loan the company has already secured.

·    TPI has R$134MM of debt maturing through September 2009, of which R$50MM is a bridge loan related to the Rio Verde power plant project, which will be replaced by the BNDS funding (the first installment of R$110MM was received in October 2008). The balance is well within the company’s ability to pay down from cash flow, should they not be able to refinance in the interim.

Catalyst