This week we are going to take a look at Brookfield Infrastructure’s (BIP.UN:TSX) recently accepted acquisition of Inter Pipeline. Brookfield first made its offer in February. It was initially opposed by Interpipe’s management and faced a competing bid by Pembina pipeline. Now it appears that the acquisition is going to proceed and we will discuss if this is a good deal for Brookfield Infrastructure investors.
Brennan will be taking a question from a long-term podcast listener, Dave, on CareRX Corp. (CRRX:TSX). CareRx is a provider of pharmacy services to senior homes. Dave would like to hear our analysis on the stock and how it stacks up against KeyStone’s investment criteria.
Ask us Anything Segment
Question from Braden:
- Q: How do I determine how much debt a business can borrow?
Question from Derek:
- Q: Do you believe that higher customer satisfaction leads to higher stock performance?
- I would say that there is a better chance for higher stock performance, but it is not guaranteed. Just because a company provides a great product, doesn’t mean that the company’s management team can execute and grow the business efficiently.
- Overall, what I think is key here is to understand any business or potential investment from the customers perspective.
- A real-world example would be a company called VentriPoint Diagnostics (VPT: TSX-V), which has developed a 2D cardiac diagnostic tool that is a cheaper and quicker way to scan the heart that competes with the more expensive and lengthy process of the MRI.
- But one thing that Ventripoint is having issues with is trying to get hospitals and clinics to adopt its products.
- From afar it only seems logical that hospitals and clinics would want to adopt Ventripoints scanning devices. But placing ourselves in the shoes of the hospitals and clinics, they are forced to take on costs to train technologists with the new equipment and overall veer away from the MRI machines which they are used to using.
- So, although cardiologists have had high satisfaction with how Ventripoint’s product performs, management’s inability to get hospitals to adopt the product could hold back the stock from positive stock performance.
Your Stock Our Take
Brookfield Infrastructure Acquisition of Inter Pipeline
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Brookfield Infrastructure (BIP.UN: TSX)
Price: $67.00
Market Cap: $20 billion
Background:
Anyone who has been following KeyStone’s research for any period of time knows that Brookfield Infrastructure has been one of our longstanding income stock recommendations. This is a global infrastructure company with a portfolio of assets that produce stable cash flow to support growing income distributions. These assets include ports, railways, data centers, toll roads, and energy infrastructure.
We originally recommended the company in March of 2011 at a price of $14.40. Today the stock trades at $67.00 and since our initial recommendation has paid out about $20.00 per unit in income distributions…more than paying back the original purchase price. We’ve put out 27 individual buy reports on the company over the last 10 years.
Recently the Brookfield Infrastructure has been in competition to acquire the fourth largest energy midstream company in Canada, Inter Pipeline. The initial offer was $16.50 per share for Interpipe which was opposed by management and resulted in a competitive bid by midstream and pipeline company Pembina. But Brookfield up its offer to $20.00 per share which caused Pembina to withdraw and Interpipeline to accept. It appears that the deal will now go through subject to regulatory approval.
The big question right now is how good of a deal is this for shareholders of Brookfield Infrastructure, particularly considering that they increased their bid from $16.50 to $20.00 per share.
The full value of the deal is C$16 billion, consisting of about $8.5 billion for the equity, and the rest is the assumption of debt. Brookfield has been pretty quiet on how accretive the deal is expected to be. This isn’t surprising as when you are doing a competitive and hostile acquisition it isn’t a great bargaining position to brag to the market about how great of a deal you are getting.
Looking at Interpipline’s financials, over the last year, the company reported about $750 million in free cash flow and just under $1 billion in EBITDA. This was down from the previous year due to a weak energy market.
On a valuation basis, this would put the acquisition at about 16 times EBITDA and 12 times free cash flow. I would not consider this to be a particularly attractive valuation. In fact, 16 times enterprise value to EBITDA looks expensive to me for an energy infrastructure company in Western Canada.
But there are a few things working in Brookfields favor here and I do have a high degree of confidence in the company’s ability to selective accretive acquisitions.
The first thing is that there is a strong likelihood that Interpipeline’s cash flow is going to grow over the upcoming years. 2020 was a difficult year due to lower energy prices. The company also overextended itself with the development of Heartland Petrochemical Complex. The $4 billion costs was the largest capital investment ever made by Interpipeline. Heartland is expected to commence operations in 2023. BIP has certainly factored this future growth into its acquisition decision as well as potentially stronger energy prices.
Another factor to consider is that BIP is not a particularly cheap stock itself. Last year, the company issued a new class of shares, BIPC which has preferred tax benefits over the BIP.UN class. BIPC share also trade at a big premium which, in addition to low interest rates, allows the company to raise capital at relatively low costs. This is a good situation for holders of the BIP.UN class of units that can be purchased at a cheaper valuation and offer a higher yield. Income-focused investors can hold the BIP.UN units, which offer better value, especially when held in an RRSP, and at the same time benefit from the lower cost of capital.
Finally, a lot comes down to Brookfield’s management and their ability to select good acquisitions that will grow per share cash flow and income distributions. They have a tremendous track record in this regard. Part of the strategy is to identify assets whereby they can add value. Eventually, these assets can be resold and the proceeds reinvested, which is what call their capital rotation strategy. For example, on July 16th, BIP announced that it was selling North American district energy business, Enwave, for $4.1 billion. Brookfield Infrastructure made its first district energy investment in 2012 and subsequently developed the business into the largest district energy system in North America. Net proceeds to BIP are approximately $1 billion. We have earned an IRR of over 30% on our investment and a multiple of invested capital of over six times.
Overall, I am optimistic that this will turn out to be a good deal for Brookfield Infrastructure over the next few years. We will get a more detailed update from the company when they report Q2 financial results in mid-August. We have always considered this company to be a core, long-term, income/growth holding and we will put out another update to our clients after the next financial report is released.
Your Stock Our Take
Came in from Dave who is a long-time podcast supporter.
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CareRx Corp. (CRRX:TSX)
Current Price: $6.22
Market Cap: $248 million
What does the company do?
CareRx is a provider of pharmacy services to senior homes and other congregate care settings. The company has 20 fulfillment centers serving over 52,000 residents in over 925 seniors and other communities.
Key Points:
- On June 22nd, 2020, the company changed its name from Centric Health to CareRX and conducted a 20:1 share consolidation. Before the consolidation, the company had approximately 289 million basic shares outstanding. But after the consolidation, the company had about 14 million shares outstanding.
- Is the company back to its old ways of diluting shareholders?
- January 2021 – issued 5 million shares at $4.25 per share for $21 million.
- May 2021 – 12.5 million subscription receipts at a price of $5.05 for gross proceeds of $63.25 million.
- So taking both these share issuances into account, just over a year since the consolidation and the company its outstanding shares are back to over 40 million common shares – which isn’t great.
- What has the company been doing with the cash? Made the acquisitions in 2021 of:
- Smartmeds (April 2021) – for $4.5 million (mostly cash on hand)
- Long-Term Care Pharmacy Division (April 2021) – for $75 million with mostly cash, revenue of $150 million. (.5x sales)
- Acquisition of a few Rexal Pharmacy group locations (June 2021) – $3.5 million. (all cash on hand)
Recent Financial Results (Q1, 2021)
- Revenue increased 47% to $44.9 compared to the same period last year.
- The revenue increase was primarily a result of the Remedy’s business acquisition, which closed in the second quarter of 2020.
- Adjusted Net Loss for the Quarter was approximately $(3.8) million, compared to a loss of $(2.5) million for Q1 of last year.
- Adjusted EBITDA was up 105% to $4.1 million or $0.15 per share, from $2.0 million or $0.14 center per share for the same period last year.
- If we include the recent $62 million equity raise the balance sheet does appear reasonably healthy.
- Including the revenue run-rates from the three acquisitions that I mentioned, the company trades with an estimated forward EV/Sales multiple of about 0.93 times.
Conclusion:
So, to conclude, I like the business as it is servicing a growing and much-needed segment in Canada as our population is aging and prescription deliveries are an essential service for care homes.
It does appear that management is making accretive purchases. And essentially, the company’s strong revenue and Adj. EBITDA performance is primarily from these past acquisitions.
However, investors need to keep an eye on the company’s dilution going forward as the company increased its basic shares outstanding by over 150% since its share consolidation. Now I am not saying that the company cannot grow accretive while issuing shares, but it is much harder to generate shareholder value over the long term compared to using internally generated funds.
So all in all, its interesting, and could potentially have some speculative value right now. But before investing I would like to talk to management to get their outlook on organic growth and an Adj. EBITDA run-rate after the acquisitions, and if they are going to continue to dilute shareholders to propel growth.
