No. of Recommendations: 14
Dalyrimple reported that the filings of the operator, by contrast, reported the capital costs of building and maintaining the road actually exceeded the toll revenues, meaning a net result that did not contribute to BIP earnings at all. The unsettling part was not so much this fact, but its omission from BIP's filings and the requirement to check the filings of other businesses to uncover it.
I have read these reports, and other derivative reports on the same subject, and you have hit the nail on the head that the overwhelmingly primary complaint is this single thing - that the capital expenditures exceeds the income streams, and because the dividend payout is covered by the income stream then the dividend really needs to be lowered to cover the true underlying cash stream available when viewing the dividend payment on sustained basis. Once subtracting the capital costs from the income available for the dividend, the true cash flow available for the dividend is insufficient. Calling it fraud accounting would be to strong, but fantasy accounting might, or "the paper world of Brookfield" are typical stances.
This sounds like a reasonable conclusion when skimming through the accounting.
The error in all of these "dividend not truly covered" reports is that the capital expenditures are viewed as maintenance cost and not improvement expenditures. The bulk of their capital expenditures are alterations, upgrades and other improvements - not simply maintenance.
Brookfield could very easily - and indeed it would be exceedingly easier to run the business in such away - just not apply any improvement capital investments, and instead invest the smallest amount possible to simply maintain their assets. This would make the accounting look wonderful and the dividend would be reported as easily recovered. But it would idiotic, or at least myopic, thinking only about the next few quarters just to make the books look as good as possible.
Let's use their office business as an example. If they have an ugly office building purchased for $130 million, that has $11 million, and $2 in maintenance, so $9 million net. They can each year just collect this $9 and all is well. After 15 years they have even paid back their initial investment!
But Brookfield purchased the particularly asset knowing that, whilst not seemingly all that cheap, does has interesting improvement potential; and they calculate that by spending $30 million on a high-tech looking glass facade, and some restaurants at the lower level, and super luxury apartment on the top two floors, they work out the their annual rent will rise to $15 million net. They go ahead.. and it takes 3 years. So they have this $30 million expense, or $10 million a year. So for these 3 years their cash flow moves from $9 million to -$1 million. Cash flow killed! Stop the dividend!
The value of the building is going up each year, despite the cash flow (after accounting for the capital costs) being negative, because their are putting real cash into a concrete (literally) purpose. The return on this capital costs is an extra *ongoing* cash flow of $6 million per year ($15 million - $9 million) from a one-off $30 million cost (a 20% return, after a 3-year lag). So it is overwhelmingly a good move, but it does make their accounting look bad because in the short-term, their dividend isn't covered by the rent minus capital cost calculation. But with a rent minus capital cost plus intrinsic value gain from higher future rent calculation, the dividend is even more easily covered than if they had done nothing, and just tried to make their books look good for some internet bloggers.
If they repeat these capital costs continuously, then their dividend coverage looks continuously bad. It would be solved instantly by adding a balance sheet item for capitalisation of capital improvements owing to rises in future income but they don't place that item anywhere. So we are always paying the hit now, for income gains later. For real investors, or workers closer to the situation, they don't think twice applying executing the capital improvement, knowing how much the income will immediately rise (relative to the expense, such as a 20% or 30% return) upon its completion. But when looking at the accounting, the future income isn't accounted for (yet) and we only see the expense. We are incorrectly comparing a stock with a flow - on the negative side, we have the stock (capital expense) and on the positive side we have a flow (the rent received). We are subtracting the stock from the flow, but not adding the stock back for the future higher income (a capitalisation of the higher future rent, which in the example about might be 15 x (additional rent) = 15 x $6 million = $90 million. This $90 million is far higher than the $30 capital cost ($10 million per year over 3 years), but Brookfield pretends for now that the $90 million doesn't exist, and will never exist, and the internet bloggers complaining about the dividend not covered therefor don't consider it.
It is much the same with their infrastructure projects. These are "projects", not "asset maintenance programmes", which means they are expanding infrastructure projects, or building the infrastructure out, similarly as they do with their buildings. The capital costs are, by definition, already capitalised - and so the figures look high when set against to the uncapitalised asset income today. But if they capitalized their additional income from the capital improvements and added that as income (which they *don't* do, as they assume investors can see the bigger picture) then this extra income from the added balance sheet item would utterly dwarf the capital expense.
What is sort of puzzlingly to me is that these reports, about the dividends not being covered, did not reconcile that Brookfield Infrastructure have been not only able to pay their dividend for many years, but also growing it. This would obviously be impossible if their dividend not covered. Sure, it is looking at the post, and maybe suddenly their business model has changed (hint: it hasn't) but that alone should send alarm bells for them as a heuristic that something is wrong with their report; at least they could be inspired to try to reconcile why their criticism couldn't have applied in the past, and conclude that the capital expenditures were not merely maintenance costs.
- Manlobbi
