Brookfield Asset Management Inc. (BAM and BAM-a.TO) has demonstrated its ability to attract funding from sophisticated institutional investors and has stated it wants to grow the number of client relationships from 630 in 2019 to ~1000 by 2023.
Its infrastructure investment arm, Brookfield Infrastructure Partners L.P. (BIP and BIP-un.TO) which invests in operating assets across the utilities, transport, energy and data infrastructure sectors has just announced an agreement to acquire Genesee & Wyoming Inc., (GWR) a Class 2 railroad with operations in the US, Canada, Australia, UK, Belgium, Netherlands, Germany, and Poland.
- I am interested in increasing my exposure to the rail industry but view the valuation of Class 1 railroads as stretched.
- BIP has just announced an agreement to acquire Genesee & Wyoming Inc., a Class 2 railroad with operations in the US, Canada, Australia, UK, Belgium, Netherlands, Germany, and Poland.
- GWR has grown through a series of acquisitions over the years and with the backing of BIP and its sophisticated wealthy investors who seek to generate attractive long-term returns, I envision further railroad acquisitions.
- Despite the 39.5% premium to GWR’s share price on March 8, 2019, the day prior to initial media speculation of a potential transaction, I am confident BIP would not make this investment unless it fully expects to generate an attractive return on investment over the timeframe in which it owns GWR.
- By owning units in BIP you have exposure to massive infrastructure projects in investor friendly jurisdictions in various parts of the world.
When looking for investment opportunities I seek industries in which the barriers to entry are extremely high. One such industry that appeals to me is the rail industry and, in particular, the Class 1 railroads; a Class 1railroad typically runs a large continental network.
At present these are the publicly traded Class 1 rail companies:
- Union Pacific Railroad
- Canadian National Railway
- CSX Transportation
- Norfolk Southern Railway
- Canadian Pacific Railway
- Kansas City Southern Railway
BNSF Railway is the 7th Class 1 railroad but this was acquired by Berkshire Hathaway (BRK.b) in 2010.
Shares in Canadian National Railway are currently held in the ‘Core’ and ‘Side’ accounts within the FFJ Portfolio. The ‘Core’ and ‘Side’ accounts also hold an interest in BNSF Railway through the ownership of BRK.b shares.
I have been monitoring UNP and CP in particular and, in hindsight, should have acquired shares in mid-December 2018 but deployed funds toward the purchase of shares in other companies. Subsequent to that timeframe, UNP and CP have appreciated in value considerably; I am waiting on the sidelines for what I think is an overdue broad market pullback.
As I await a retracement in the share price of these two railroads I see that on July 1, 2019 Brookfield Infrastructure Partners L.P. (TSX: BIP-un) (NYSE: BIP) announced an agreement in which it and GIC will acquire Genesee & Wyoming Inc. (GWR) in a transaction valued at approximately $8.4B including debt resulting in GWR becoming a privately held company; BIP is one of the entities within our largest 20 holdings (the Brookfield Asset Management group of companies (TSX: BAM-a) (NYSE: BAM).
NOTE: GIC is a leading global investment firm established in 1981 to manage Singapore’s foreign reserves. GIC has investments in over 40 countries and it invests across a wide range of asset classes, including equities, fixed income, private equity, real estate and infrastructure. In infrastructure, GIC’s primary strategy is to invest directly in operating assets with a high degree of cash flow visibility and which provide a hedge against inflation.
In my October 4, 2018 BIP article I explained why I had decided to acquire units for the FFJ Portfolio. One of the factors which led me to invest in BIP is that it is one of the largest owners and operators of critical and diverse global infrastructure networks which facilitate the movement and storage of energy, water, freight, passengers and data. One of its objectives is to generate a long-term return of 12 - 15% on equity and provide sustainable distributions for unitholders while targeting annual distribution growth of 5 - 9%.
Although increased exposure to the rail industry through the purchase of additional BIP units is what immediately appeals to me, there is no guarantee BIP will acquire more rail companies. Even if BIP ultimately decides not to increase its exposure to the rail industry, an investment in BIP provides me with the opportunity to share in the profits of several other operating assets across the utilities, transport, energy and data infrastructure sectors.
For now, let’s have a very high level look at the rail industry in the various regions in which GWR has operations.
According to the Association of American Railroads 2018 Railroad Facts Book, there were 613 freight railroads in the US operating over ~137,000 miles of track. The 7 Class 1 railroads listed earlier operate 93,058 miles of track. The remaining ~44,000 miles of track are operated by 22 Class 2 railroads (~11,000 miles) and 584 Class 3 railroads operate ~32,800 miles of track.
According to Rail Trends 2018, published by The Railway Association of Canada, there are ~26,400 miles (42,500 kilometers (km)) of track operated by railroads in Canada.
Australia has ~25,000 miles (40,000 km) of both publicly and privately owned track that link major capital cities and key regional centers and also connect key mining regions to ports.
Since Australian rail customers have access to multiple rail carriers under open access regimes, all rail carriers face possible competition on their above rail business from other rail carriers, as well as from competing modes of transportation, such as trucks. The open access nature of the Australian rail freight transport industry enables rail operators to develop new business and customer relationships in areas outside of their current operations, and there are limited barriers to entry that preclude any rail operator from approaching a customer to seek new business. Shipments of bulk commodities, however, are generally handled under long-term agreements with dedicated equipment that may include take-or-pay provisions and/or exclusivity arrangements, which make capturing new business from an existing rail operator difficult.
According to Network Rail, the authority responsible for Great Britain’s railway network, there are ~20,000 miles (32,000 km) of track owned and managed by it, and there are seven rail operators licensed for freight transport in Great Britain.
Great Britain’s rail network is also open access, which means rail lines can be utilized by any licensed rail operator with an appropriate track access agreement in place. In the U.K.'s open access framework, the infrastructure managers must provide access to the rail infrastructure to all accredited rail service providers, subject to the rules and framework of each applicable access regime. As a result, U.K. rail freight customers have access to multiple rail carriers under the open access regime, and our operations face competition from both other rail freight carriers and other modes of transportation, such as road and water.
In 2017, 9% of all freight goods were moved by rail, while over the same period, 78% and 13% of goods were moved via road and water, respectively.
According to Infrabel, the Belgian railways infrastructure manager, there are ~2,238 miles (3,602km) of track owned and managed by it on the Belgian rail network, and currently there are 12 rail operators licensed for freight transport in Belgium. As a result of the country's open access regime, this track may be accessed by any operator admitted and licensed to provide freight transport in the country.
The German rail network is composed of ~20,654 miles (33,241 km) of track. There are approximately 385 rail operators certified for freight transport in Germany. In Germany, as well as in other Continental European markets, the leading rail freight operators are often state controlled, such as DB Cargo AG. As a result of Germany's open access regime, the rail infrastructure may be accessed by any licensed rail operator.
According to ProRail, the entity responsible for the Dutch rail infrastructure, there are ~4,363 miles (7,021 km) of track owned and managed by it on the Dutch rail network. As a result of the open access regime, this track may be accessed by any admitted and licensed rail operator. According to ProRail, there are 21 rail operators that provide rail freight services.
According to the Office of Rail Transport, the railway regulator in Poland, there are ~114 rail operators certified for freight transport operating over ~11,939 miles (19,214 km) of track. As a result of Poland’s open access regime, this rail infrastructure may be accessed by any admitted and licensed rail operator.
BIP – Potential Expansion in the Rail Industry
The BAM group of companies are astute and opportunistic investors who have access to deep pools of capital. They have demonstrated an ability to acquire assets and to significantly grow them in value over a period of years.
Naturally, I am not privy to potential BIP deals but GWR strikes me as just the beginning of what might be a series of acquisitions by BIP in the North American rail industry. Here is why…..
GWR is a decent sized Class 2 North American railroad having increased its annual revenue at a compound annual growth rate of 16.8% (from $77.8 million in 1996 when it went public to $2.3B in 2018).
This growth has come through multiple acquisitions over the years and it now owns or leases 120 freight railroads which are organized in 8 locally managed operating regions. It has 8,000 employees, 16,000 miles of track, serves 3,000 customers, and it pulls ~3.3 million carloads/year.
As of December 31, 2018, GWR was organized in 9 geographic regions of which 7 are in North America; 80% of GWR’s Operating Income is generated from its North American operations.
GWR’s ‘North American Region’ serves 41 U.S. states and 4 Canadian provinces. It includes 114 short line and regional freight railroads with more than 13,000 track-miles.
- Central (which includes industrial switching operations);
- Coastal (which includes industrial switching and port operations);
- Midwest, Northeast, Southern, Western and Canada.
The ‘Australian Region’ serves New South Wales, the Northern Territory and South Australia and operates the 1,400-mile Tarcoola-to-Darwin rail line. The ‘Australia Region’ is 51.1% owned by GWR and 48.9% by a consortium of funds and clients managed by Macquarie Infrastructure and Real Assets (MIRA).
The ‘U.K./Europe Region’ consists of operations in the U.K., Germany, the Netherlands and Poland, as well as the provision of management and technical support through Freightliner Group Limited (Freightliner) to Saudi Railway Company.
GWR’s subsidiaries and joint ventures also provide rail service at more than 40 major ports, rail-ferry service between the United States Southeast and Mexico, transload services, contract coal loading, and industrial railcar switching and repair.
- have GWR which is a decent sized Class 2 North American railroad that has grown through multiple acquisitions over the last few decades and which also has operations in other regions of the world;
- have some of the other 21 other potential Class 2 North American railroads whose rail network might have little overlap with that of GWR;
- have the BAM group of companies which has demonstrated its ability to attract funding from sophisticated institutional investors and has stated it wants to grow the number of client relationships from 630 in 2019 to ~1000 by 2023 (see page 10 of BAM’s June 14, 2019 AGM presentation).
Is it unrealistic to think that BAM, through BIP, could potentially be looking to expand its presence in the rail industry? I think not.
Investing in BIP
BIP’s Investor Fact Sheet can be accessed here.
What I find particularly appealing about BIP and the other BAM entities is that they adhere to the following 5 core principles:
- Acquire high quality assets;
- Invest on a value basis;
- Enhance value through operations;
- Contrarian investing;
- Large-scale and multifaceted.
It is imperative that an investor in any one of the BAM companies realize that the manner in which the BAM businesses operate entails the use of a capital recycling program. When an asset is acquired, the intent is not to hold the asset in perpetuity. The capital recycling program instills capital discipline to ensure that businesses are sold when returns are maximized and not when cash is needed.
The BAM entities look for assets in which they can use their expertise to enhance the value of the acquired business. Unlike some members of its small peer group and institutional investors, the BAM entities have the expertise to acquire businesses in need of an overhaul and to make enhancements to increase the value of the acquired assets. Once the asset reaches the stage where it is almost ‘bond like’ the objective is to sell the asset and to redeploy the net sale proceeds into other assets where there are opportunities to generate superior returns.
In fact, at the September 26, 2018 Brookfield Investor Day, management explained that its capital allocation priorities are as follows:
Out of every $1 of Funds from Operations (FFO), BIP allocates:
- ~20% to maintenance CAPEX obligations;
- ~15 - 20% reinvested in hundreds of smaller very low risk recurring projects that the business is able to predictably source year in and year out;
- ~60 - 65% distributed to unitholders.
In a nutshell….
- BIP generates significant free cash flow;
- Recurring organic growth is funded by operating cash flows;
- New investment activities and large scale expansions are funded from asset sales and capital market raises.
While Adjusted Funds from Operations is a non-IFRS measure it is the measurement of financial performance the BAM group of companies most heavily relies upon. The rationale for using this metric (generally equal to funds from operations (FFO) with adjustments made for recurring capital expenditures used to maintain the quality of the underlying assets) is that it is considered to be a more accurate measure of residual cash flow for unitholders; BAM has specifically stated on multiple occasions that this metric is the closest proxy to cash flow generated from the business on an annual basis.
I view the BAM entities as a component of the ‘alternative assets’ segment of my overall holdings. My definition of ‘alternative assets’ might differ from other investors who invest in gold, private equity firms, crypto currencies, etc. but I do not hold any of these types of investments.
I look at the BAM entities as my chance to ‘piggy back’ on the ‘serious wealth’ which entrusts BAM to invest money over a period of several years with the expectation of receiving an attractive return.
Quite frankly, I do not delve into whether the 39.5% premium to GWR’s share price on March 8, 2019, the day prior to initial media speculation of a potential transaction, is reasonable or not. I figure that BAM/BIP has enough experience to determine what constitutes a reasonable per share offer. Secondly, I have no idea what BAM/BIP intends to do with GWR if/when it closes the purchase. The fact, BIP is prepared to pay such a premium suggests to me that it has a game plan to enhance the value of GWR over the next several years while could very well include bolt-on acquisitions.
The BAM entities have developed a track record of acquiring companies, enhancing the performance of these companies, and then selling them at a premium ~5 – 10 years into the future. Their success at doing this is why they have 630 client relationships and plan to increase this number to ~1000 by 2023. What is equally impressive is that BAM’s clients typically end up being ‘repeat’ clients. If BAM wasn’t generating sufficiently attractive returns it would not have ‘repeat’ clients which would be sufficient cause for concern for me not to invest in BAM and its limited partnerships.
Rewarded For Being Patient
I have no empirical evidence but I strongly suspect many investors look at investing from a short-term perspective. The business news networks likely contribute to this in that the focus is predominantly on what is happening at the very moment.
When investing in high quality companies it is important to invest from the perspective of being a long-term business owner. It is even more critical that you think long-term when investing in BIP because acquiring ports, toll roads, utilities, or railroads is not like investing in a company which has launched a ‘sexy’ new product that everyone wants to own right away because of some celebrity endorsement.
In exchange for investor patience/discipline, BIP rewards investors with an attractive quarterly distribution.
In all probability, the GWR acquisition will not generate attractive returns in the short-term. BIP, however, has several other infrastructure investments within its portfolio which generate FFO to service the quarterly distributions.
I encourage you to look at BIP’s May 27, 2019 Presentation from the Industrial Alliance Conference. In particular, look at page 8 of 20 wherein a comparison between BIP’s per unit FFO and per unit distribution is provided for the 2009 – 2019 timeframe; FFO growth outpaces distribution growth by a wide margin.
BIP’s quarterly distribution history (expressed in USD) can be accessed here.
The June 28, 2019 distribution marked the 2nd consecutive $0.5025 quarterly distribution. For the benefit of investors interested in acquiring Canadian dollar denominated units, the March 29 and June 28, 2019 distributions amounted to ~CDN $0.6617 and ~CDN $0.6797.
BIP was trading at ~$55.81 on March 29 and ~$56.13 on June 28 so investors essentially received a distribution yield of ~4.75% - ~4.85%.
NOTE: These quarterly distributions are made through a limited partnership so the tax treatment differs from regular dividends.
I have closely followed BAM for over a decade as I initiated an investment in BAM on February 18, 2009.
In June 2018 I had the good fortune of being able to attend BAM’s AGM in Toronto for the first time since becoming a shareholder and I came away even more impressed with this group of companies. This prompted me to acquire more shares in BAM and to increase my position in the limited partnerships disclosed at the end of this article.
This year I missed BAM’s AGM due to other commitments but I continue to closely follow these companies given my exposure to the BAM entities.
In my opinion, an investment in BAM and its limited partnerships is an ideal way for investors to participate in investments in which the ‘wealthy of the wealthy’ entrust their money to BAM for the purpose of generating attractive returns over the long-term.
By investing in BIP in particular, an individual investor can participate in the profits generated from ports, hydro dams, toll roads, railroads and other infrastructure projects located in various regions of the world that are typically investor friendly; BAM will study a country for years before it makes its first investment in that country. This suits me because, while some regions of the world might currently appeal to investors because of their growth opportunities, I have no desire to invest in higher risk countries; I am prepared to entrust my money with the BAM entities because they are far more familiar with the investment environment in countries such as Australia, Germany, the UK, etc.
I mentioned at the outset of this article that I am very interested in increasing my exposure to Class 1 North American railroads and currently only own shares in BNSF Railway through my Berkshire Hathaway holdings and in Canadian National Railway. I, however, currently view the Class 1 railroads as somewhat expensive and am patiently waiting for a broad market pullback.
When I read that BIP had recently announced an agreement in which it and GIC will acquire Class 2 GWR, my interest was piqued. While GWR is small relative to the Class 1 North American railroads I think BIP has plans to grow GWR. GWR has grown through multiple acquisitions over the years and BAM and its investors have very deep pockets. This strikes me as a combination which will lead to a much larger GWR over the next few years.
As I indicated earlier in this article, I am not just investing in BIP because of the GWR acquisition; BIP brings much more to the table than a Class 2 railroad.
In my opinion, BIP presents you with an opportunity to generate ~4.75% - ~4.85% on your money while it goes about weaving its magic. On this basis, I have acquired additional BIP units for a ‘Side Account’ within the FFJ Portfolio.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: Long BIP, BPY, BEP, and BAM.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.