No. of Recommendations: 10
I guess where I have trouble with this argument is the idea that the earnings will ALWAYS look bad as long as they are investing a lot in improvements.
The complaint as I understood was that there is not sufficient cash flow from (rent/income minus capital costs) to cover the dividends, rather than there isn’t enough available cash generally. Part of the income comes from rent/income and part comes from asset sales above purchase cost (capital gains). The articles didn’t want to take the capital gains a seriously.
The assertion that capital gains are speculative and cannot be relied on, beyond inflation, makes a lot of sense if the assets were not being improved; in other words the capital expenses (not increasing intrinsic value but just maintaining it) are merely maintenance, rather than actual improvements - including literally expanding solar farms, adding restaurants or preatigious facades to buildings that were not there before and so on.
It may be useful to look at it in the following way. Imagine that they perform no improvements and just maintain their assets. Now their cash flow from rent/income paid directly from the assets (rent, tolls, power purchased, etc) would exceed the dividend payment. All good. The phantom income articles would not have appeared. We have capital gains in line with inflation only, plus the rent, and the dividend is covered. Everyone is happy. Brookifeld have lower total returns but the books are easier to read.
Now imagine step 1 - they make further increments to improve the assets. Let’s say we build such that for each $1 and get $1 back in intrinsic value gain.
In this situation, we now have larger capital expenses, and the calculation of (rental/income - capital expense) may now not be enough to cover the dividend. However the capital gains will be higher, so if we add the extra income from capital gains back in, then we are back at the previous situation really and the dividend is still covered. We have just spent $1 to improve IV by $1 so there is no real change, both with cash coming out of the business over the long-term, nor the IV increase long-term. It will be lumpy but over time the IV gains match the extra capital expense.
We are back at the earlier situation - the dividend is still covered but we need to, and very reasonably, count our higher capital gains which are heightened by the higher improvement expense in the past. Still all good - but the improvements were almost useless in this case as we got back only $1 for each $1 spent.
Now imagine step 2 - adjust the strategy further to only make improvements when when we are, on average, sure that that we will get back $2 in IV gains for each $1 spent.
Now the rent minus capital expense still doesn’t cover the dividend, and the articles are coming out saying Brookfield is living in a fairy tale - but the extra capital gains not only offset the capital expense but now exceed it. So the dividend is not only covered but easily covered provided we sell improved (as they say, mature) assets occasionally to realize some of tbe IV gains.
The articles were looking at it simplistically as if the capital gains are just random fluff and should be ignored. They are accounting for the loss from improvement expense but not adding that back in the capital gains from substabtially improved (vs unchanged) asset sales.
- Manlobbi
