7/29/15

Macquarie: An Infrastructure Dividend Growth Investment

Macquarie Infrastructure Corporation (MIC) is a holding company (that operates like a fund--more on this below) that owns, operates, and invests in infrastructure businesses in the United States and Canada. The company is expected to report earnings in early August, with the conference call scheduled for the morning of August 4, 2015.

Reasons to Consider Investing
  • Trading around $82 per share, MIC currently yields around 5%, which is in the upper range of its historical dividend yield.
  • All of MIC's 2014 distributions were tax deferred because they were classified as return of capital. This may be the case with at least a portion of 2015's distribution.
  • The company has a strong history of dividend increases, growing its distribution 435% since 2011, from $0.20 per quarter to $1.07 in the last quarter.
  • Management expects the full 2015 dividend to be 14% higher than 2014.
  • Management has forecast additional 14% dividend growth in 2016.
  • The company does not expect to have significant Federal tax liability until late 2018.
  • With its recent conversion from an LLC to a regular c-corporation, MIC is now eligible for inclusion in stock indexes, which may boost its share price.
  • MIC's portfolio companies operate in markets with high barriers to entry.
  • Management has displayed a nimbleness in acquiring and divesting assets to maximize cash flow.
  • Management is open to spinning off some of its assets into a REIT or MLP if that will increase shareholder value.
  • MIC's external management structure and performance fees provide managers with an incentive to grow the share price and dividend distribution.
Reasons to Pass (or short)
  • Rising interest rates may drive the share price lower as investors seek safer income producing assets.
  • As over 60% percent of MIC's portfolio EBITDA comes from energy related revenues, volatility or disruptions in the energy market may have a negative effect on the share price and dividend.
  • As MIC targets its dividend payout to be 80% to 85% of cash flow, there is narrow margin for error in maintaining and growing the dividend.
  • Since so much of MIC's cash generation goes to dividend payouts, the company must rely on debt and/or new equity issuance to finance growth. New equity issuance dilutes existing shareholders.
  • Rising interest rates may increase MIC's cost of capital, which may lower the fund's return.
  • The better MIC does with respect to its benchmark, the higher its management performance fees. These, along with the regular management fee, are paid in cash or shares. When paid in shares, the fees dilute existing shareholders.
  • As two of MIC's portfolio companies (the gas and bulk liquids segments) have defined benefit pensions, disruptions in the financial markets may adversely affect their businesses, and thus, MIC's results.
  • Two of MIC's major facilities are located next to each other in Bayonne, NJ. One generates power and the other deals with bulk liquids. Any sort of accident, weather, or terrorist related event at one site can disrupt the other site, to the serious detriment of MIC's bottom line.
  • MIC's structure as a fund or holding company makes it depend on cash flows from its businesses, which may impact its ability to pay or increase dividends in the future.
  • MIC's debt agreements have various restrictions on what it can and cannot do, and this may also affect its ability to pay dividends in the future.

MIC's Manager

The Macquarie Infrastructure Corporation is managed externally by Macquarie Infrastructure Management USA Inc. (MIMUSA). See the agreement here. You can learn more about Macquarie's other funds here.

One of MIC's largest shareholders, MIMUSA collects a base monthly management fee based in part on MIC's market value. MIMUSA also collects a 20% quarterly performance fee when MIC outperforms its benchmark. In the last fiscal year MIMUSA collected $46.6 million in base management fees and $121.5 million in quarterly performance fees. While these fees dilute existing shareholders when they are paid in shares, they have the effect of lowering MIC's income tax liability.

MIMUSA is a member of Macquarie Group Limited, a global provider of financial, advisory, investment, and funds management services. The company trades in Australia, but has a thinly traded American Depository Receipt on the Pink Sheets with the ticker MQBKY. It pays a biannual dividend. Its last payment annualized yielded around 4%.

MIC's Portfolio Companies

The Macquarie Infrastructure Corporation owns four businesses. In order of percentage of MIC's EBITDA (earnings before interest, taxes, depreciation, and amortization) from the last fiscal quarter, they are International-Matex Tank Terminals (50.3%), Atlantic Aviation (36.1%), HAWAI'IGAS (10.8%), and Contracted Power and Energy (2.9%). (Rounding errors take this slightly over 100%.)

International-Matex Tank Terminals (IMTT)

IMTT operates bulk liquid terminals in New Jersey, Louisiana, Virginia, Illinois, and California in the United States and in Quebec and Newfoundland in Canada. The New Jersey terminal accounts for 40% of IMTT's gross profits. It is the largest independent bulk terminal in New York Harbor, the main petroleum trading hub in northeast United States.

During the last fiscal year IMTT's revenues were made up of 57% petroleum, 21% chemical, and 6% renewable vegetable and animal oils. The remaining 16% of IMTT's revenues came mostly from spill response activity. Emergency environmental services is probably the most volatile of IMTT's business areas because it cannot be predicted when an accident or an act of God occurs that will necessitate environmental cleanup.

Companies already established in the bulk liquid terminals business have several competitive advantages over potential newcomers. Barriers to entry include high start up costs, difficulty in financing those costs, the scarcity of new personnel with the skills for the operation, the shortage of new waterfront space near supporting infrastructure, increasingly strict environmental laws and long waits for permits, and strong resistance against new facilities by local residents.

The latter two barriers can be a double edged sword, however. While they keep newcomers out, they also make it harder for established players to expand not only into new areas but also their existing facilities. Vehement resistance to TransCanada's (TRP) Keystone Pipeline and Kinder Morgan's (KMI) recent troubles in Canada and Georgia are two high profile examples of a growing trend.
IMTT's bulk liquids customers include the oil and chemical majors, food processors, and traders of agricultural, chemical, and liquid petroleum products. With about half of IMTT's sales coming from its 10 largest clients, the company says it doesn't depend on any one customer for the bulk of its revenues. The business's clients usually sign three to five year contracts with fixed monthly payments.

During the last fiscal quarter the impact of lower oil prices, according to CEO James Hooke, was neutral to a mild positive.

IMTT's risks include volatility in the financial and commodity markets, accidents, terrorism, and acts of nature, stricter regulations, and the creditworthiness of customers in multi-year contracts. The company also has location risk in that 40% of its gross profits come from one facility. Any disruption at this one site may significantly affect MIC's bottom line.

Atlantic Aviation

Atlantic Aviation operates a heliport in New York City and a network of 69 fixed based operations (FBOs) on leased land at airports throughout the United States. The FBO business offers terminal operations, refueling, aircraft parking and hangar services, and de-icing for corporate and private jets as well as the government and military.

During the last fiscal year around 64% of Atlantic's gross profit was generated by fueling and fuel related services. While the company buys jet fuel at wholesale and sells it to customers at either a contracted price or one negotiated at the point of purchase, it does not have significant exposure to fuel prices for two reasons. First, it carries a small inventory of fuel on its books. Second, in the normal course of businesses Atlantic passes fuel cost changes on to its customers.
Atlantic's weighted average lease at the end of the last fiscal year was 18.8 years, with seven leases (accounting for 11.2% of Atlantic's gross profit) expiring in the next five years.
The company continually evaluates its FBO sites. Where it finds there is little room for growth it either sells the leases or elects not to renew them. In the last seven years Atlantic got rid of 12 such locations.

The company uses the same methodology for new sites. In April 2014 it acquired one site in Colorado and five in Florida, which has been a source of strength in the most recent quarter. In January 2015 Atlantic added another FBO in Florida.
This segment of MIC's portfolio also comes with significant barriers to entry. They include high start up costs, a lengthy government approval process, and high requirements for operational experience. As a result, only three competitors own more than 20 FBOs. Atlantic's main competitor is Signature Flight Support.

Risks to Atlantic's business include weather, stricter regulations, downturns in the economy and private jet use, higher lease rates at airports, and customer preferences for other FBOs.

HAWAI'IGAS

Founded in 1904, the company distributes liquefied petroleum gas and produces and distributes synthetic natural gas to Hawaii's six major islands through its about 1,000 miles of underground piping. As Hawaii's only government-franchised gas utility, the company has around 35,000 customers. It also serves another 34,000 non-utility customers with portable gas cylinders and on-site propane tanks.

Because Hawaii's government and residents are increasingly environmentally conscious, HAWAI'IGAS is making efforts to use renewable natural gas.
The gas business has both regulated and unregulated revenue. The unregulated part of the business has contracts with customers that range from three to five years. The regulated rate for utility customers, on the other hand, is set by the government regulator HPUC. Nevertheless, the company is allowed to pass changes in raw materials costs on to its customers.

The utility business has no competition from other gas companies, but customers can switch to other fuels (diesel, solar, electric). There are also four electric utilities on Hawaii's islands as well as other independent power producers. Many of Hawaii's residents and businesses also use solar power.

In the unregulated gas market, the company faces competition from two wholesale companies and a smattering of smaller retailers.

Risks to MIC's gas businesses include stricter regulations, disruptions in the raw materials chain (the company buys raw materials from off island producers and gets all of its feedstock for synthetic natural gas from one company), accidents, terrorism, acts of nature, and disruptions in the financial markets.

Contracted Power and Energy (CP&E)

MIC's Contracted Power and Energy segment owns controlling interests in two contracted wind power facilities and five contracted solar power facilities. The wind power facilities are located in Idaho and New Mexico and can generate 203 megawatts of power. The solar facilities can generate a total of 57 megawatts and are located in Arizona, California, and Texas. Contracts with customers range from 20 to 25 years.

After selling its district energy business in 2014, CP&E acquired the Bayonne Energy Center in New Jersey in April 2015. The gas burning facility produces 512 megawatts, which goes to power New York City. The facility is located right next to IMTT.

CP&E's EBITDA for 2014 was $22.7 million. MIC expects the segment to generate $75 million of EBITDA in 2015, reflecting three quarters of ownership of the BEC facility.
Because of the long term nature of its contracts, the CP&E segment does not face substantial competition. There are risks, however. The solar and wind power facilities are subject to seasonality and weather. The solar plants generate most of their power during the summer. The wind facilities' peak performance varies by location. CP&E can cut costs and aim to be more efficient, but it cannot control nature's variability. Moreover, this segment of MIC's portfolio is subject to the volatility of electrical demand in the markets it serves. Other risks include accidents and terrorism, and the creditworthiness of its local utility customers.

Conclusion

During the last conference call CEO James Hooke stated that the company was on track in 2015. He predicted a 14% dividend increase in the full year over 2014 and another 14% increase in 2016. He also stated that MIC's Federal income tax liability should be minimal at least through 2018. If the corporation embarks on more acquisitions or capital spending, the tax shield will be pushed out further into the future. The next conference call in early August should provide more clarity.

I was long MIC and TRP when this post was written.