Share price weakness creates opportunity for income investors – 8.1% Qualified Yield and 36% capital gains potential.
Macquarie Infrastructure (MIC) is an often-overlooked income opportunity with nice capital appreciation potential. While not the 50-bagger it was from 2009 to 2016, MIC offers attractive total return opportunities.
For me, there is a back story of MIC. In 2005, I was a shareholder of Macquarie Group (MQBKY), an Australian investment bank. My interest in the bank was the compulsory retirement savings program instituted in 1992 by the Australian government, whereby all employers MUST contribute 9.25% of employee income to a third-party managed, tax advantaged account, similar to our 401(k). The mandatory contribution is slated to rise to 12% by 2020. Employers contribute into tax-advantaged retirement plans for virtually all employees age 18 to 70, with employees choosing where to invest the funds. Annual account income is taxed 10% as it accrues and a 15% capital gains tax on realized profits from investments held more than a year. But as with America’s Roth IRAs, retirement withdrawals are tax-free. Australians can begin withdrawing their money at 55, if they’re retired.
This program creates a very large pool of capital that generates substantial fees for managing banks. In response to the flood of capital, Macquarie Bank started forming asset funds whereby, much like our MLPs, fund investors own hard assets, such as airports and toll roads, and hires the bank as business managers. However, there is no MLP-like tax advantages, and is considered as a different corporate structure. Macquarie Bank has been quite successful in generating bank fees for itself and income and capital gain returns for fund holders.
Management came to the US with a similar investment strategy. Macquarie Infrastructure is an offshoot of similar businesses Macquarie Bank operates in Australia. Due to buying assets with substantial depreciation factors, MIC is able to show substantially larger operating cash flow than taxable earnings. MIC owns hard assets with long asset lives and high tax depreciation levels.
With the goal of dispersing a majority of operating cash flow, MIC offers a current yield of 8.11%. MIC’s business model is to buy assets with high EBITDA and high depreciation supporting a high distribution. Like REITs and MLPs, MIC should be viewed from a cash flow perspective and not the usual EPS viewpoint.
Shares came public in Dec 2004 at $30 a share and topped out at $40 in May of 2007. When share prices retreated to under $15 in Sept of 08, I took a starter position of 150 shares. Then the preverbal hit the fan – in more ways than one.
The company’s assets at the time included partial ownership of bulk liquid tank storage facilities, private airplane flight services, partial ownership of 2 niche utilities, and a network of off-site airport parking facilities. Of importance is the debt structure MIC maintains with each operating subsidiary carrying its own credit risk with little to no recourse back to the holding company. This is a critical debt term which protects shareholders again subsidiary bankruptcy.
The airport parking business took a real hit in revenue and profitability during the Great Recession, eventually this subsidiary filed for bankruptcy and was jettisoned from the holding company, MIC.
With the slow demise of the parking business, and the overall market sell-off, share prices collapsed to under $5 by late 2008 and to under $2 by Dec 2009. Thinking the market had overdone the risk of the parking lot subsidiary bankruptcy spreading to other parts of the company and the whole business imploding, I decided to buy shares in the $2.89 to $1.49 range. Implementing my usual profit taking strategy, I had exited all shares by the end of 2012 at the highest price of $45. If only my legs were longer to kick myself in the arse as shares continued to rise to another doubling.
I have followed MIC since, and recently instituted another position. The decline of MIC shares over the past few months has been in sympathy to movements in the MLP markets.
MIC currently owns 100% of its bulk liquid storage facilities, private airplane hangar and flight services, an interest in the Hawaiian gas utility, and solar/wind power generating facilities. The bulk storage and aviation businesses generate the majority of EBITDA cash flow at 78%.
MIC owns International-Matex Tank Terminals. Mainly located at shipping points such as export terminals (Bayonne, NJ is pictured above), the company operates 12 facilities, ten in the US and two in Canada. The terminals handle primarily refined petroleum, chemicals, and vegetable and animal oil products for customers including refiners, commodities traders, and specialty chemical manufacturers. Customers retain ownership of the bulk liquids, as well as responsibility for insuring those products. MIC operates more than 45 million barrels of storage capacity.
Management recently moved to expand their petroleum bulk liquids exposure with the purchase of privately-held Epic Midstream, adding another 7 terminals in the US and 7% overall storage capacity.
These facilities utilize long-term, take-or-pay contracts which support long-term stability in in income and distributions. Since 2007, capacity utilization has ranged from 92% to 96%, with a current reading of 92%, below management’s long-term goal of 94% utilization.
The other large portion of MIC’s business is Atlantic Aviation. Known as fixed-based operations, or FBO, Atlantic is one of the largest operators in the country, based on its 68 locations. FBOs primarily serve the corporate and private jet segment of the general aviation industry. Services include terminal operations, refueling, de-icing, aircraft parking, and hangar storage services. Atlantic is well represented in the economic and tourist hubs around the country.
Corporate-wide, management has guided to cash flow growth of 10-15% per year in 2017 and 2018. Consistent with this guidance, the company also expects to increase its dividend by 10% in both years.
While I don’t expect share prices to grow by 30 times as my previous position had, the 8.1% income is quite attractive. The best part of the income for many investors is: No K-1s and the distribution is qualified.
Two factors may offer investors pause: net debt and management performance fees. Currently, the company holds $3.5 billion in debt vs a market capitalization of $5.9 billion. However, much like the structure in the early years that saved the company from its bankrupt airport parking subsidiary, the holding company’s direct exposure is around $750 million with the balance being non-recourse to the parent. As shown in the past, this structure offers protection for investors in the unfortunate event of a bankruptcy of one of its subsidiaries.
The other concerning factor is the performance-based compensation for management services. Remember, shareholders own the assets and contract out for management services to the Australian investment bank. Management fees are set at $75 million a year, which is not a large amount on revenues of $1.7 billion. However, performance fees are based on share price performance. The performance fee is paid quarterly, with management taking 20% of the excess total return of MIC stock over the MSCI Total Return Utilities Index. When MIC share price exploded from 2012 to mid-2015, management collected $526 million in performance fees: $67 million in 2012, $53 million in 2013, $122 million in 2014, and $284 million in 2015. None have been paid since.
To the benefit of shareholders, performance fees are reset quarterly and have a high-water mark. Given the poor performance of the stock since June 2015 relative to the utility index, MIC should pay zero performance fees until the stock gets back to almost $100 per share. In the past, performance fees have been paid in stock rather than cash, improving cash flow but also diluting current investors. MIC's total return can rise by 45% before the next “high-water mark” for performance fees is reached.
Free Cash Flow per share has grown from $4.66 in 2015 to an estimated $5.70 in 2017. Next year, FCF/share should reach roughly $6.50 per share. It is this FCF growth that will continue to reward shareholders.
The company just announced a $1.42 per share quarterly dividend, and a 2.9% increase from prior dividend of $1.38. This rate equates to a forward yield 8.11%. The dividend is payable on Nov. 16 for shareholders of record of Nov. 13 and an ex-div Nov. 10. With the recent decrease in mandatory trade settlement days, it is advisable to buy shares before Nov 7 to receive the mid-Nov distribution.
While not necessarily a mainstream recommendation, MIC should be attractive to investors seeking higher income without the “complications” of K-1s, and with only about half the EBITDA exposure to oil and gas markets as many MLPs. For income diversification, MIC should be on your research list.
Although I am not expecting a 50+ times cost capital gain, similar to its move from $1.58 to $90 a share, MIC should offer attractive total returns, cemented in its current 8.11% yield.
Thanks for reading. This article first appeared in the Nov 2017 issue of Guiding Mast Investments, George Fisher
