Many factors can cause a company to trade at a relatively lower valuation. It might have balance sheet issues, lack growth prospects, or have a more complex corporate structure.
That last issue seems to be the driving factor behind the low valuations of Brookfield InfrastructurePartners(NYSE: BIP) and Energy Transfer(NYSE: ET). They're both publicly traded limited partnerships. Those entities have some tax complexities, which tend to weigh on their valuations compared to traditional corporations. However, those lower valuations enable investors to lock in a higher income yield, which can make them richer over time.
1. Brookfield Infrastructure Partners: An eye-popping discount
Brookfield Infrastructure Partners currently trades at around $35.50 per unit. That's a more than $10 discount from the recent trading price of its corporate twin, Brookfield Infrastructure (NYSE: BIPC). It's a confounding discount, since the economically equivalent companies have the same earnings ($0.72 of FFO per unit/share in the first quarter, or $2.88 per unit/share annualized) and dividend payment ($0.3825 per unit/share each quarter or $1.53 per unit/share annually).
As a result of its lower price, Brookfield Infrastructure Partners trades at a much lower valuation. Brookfield Infrastructure Partners sells for 12.3 times FFO, while Brookfield Infrastructure trades at 15.9 times FFO. Both entities also trade at a discount to the broader market (the S&P 500 trades at nearly 20 times earnings).
Meanwhile, given their same dividend rates, the partnership offers a higher yield (4.3% versus 3.4%). That higher yield would turn every $1,000 invested in the partnership into $43 of annual dividend income, versus $34 for investors in the corporation. The extra income will really add up over the years.
There's no logical reason for the wide disconnect other than investors favoring the ease of owning shares of a corporation (and receiving a 1099-Div form for taxes) over the added tax complexities of investing in a partnership (and receiving a schedule K-1 form for taxes). In addition, some already tax-advantaged accounts (IRAs) don't allow investors to hold partnership units, and many stock market indexes don't allow partnerships.
Brookfield Infrastructure is using this disconnect to its advantage. The company and its partners recently agreed to acquire Triton International in a cash-and-stock deal, valuing Triton's equity at $4.7 billion. Brookfield Infrastructure will fund about $900 million of its $1 billion equity commitment with shares of Brookfield Infrastructure. The higher corporate share price allows Brookfield to use that stock as currency to make accretive acquisitions.
2. Energy Transfer: A low value gives it a high yield
Energy Transfer expects to generate $13.1 billion to $13.5 billion of adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) this year. The master limited partnership (MLP) currently has an enterprise value (EV) of $95.2 billion. That puts its valuation at 7.2 times EV to EBITDA. That bargain-basement valuation is why the MLP currently yields 9.6%.
That's a lot higher yield than many other pipeline stocks. For example, Williams (NYSE: WMB) and Oneok(NYSE: OKE) currently yield 5.9% and 6.3%, respectively.
There's no logical reason for the disconnect other than investors favor owning shares of a corporation over units of an MLP, since Energy Transfer's financial profile and growth prospects rival those of Williams and Oneok. Energy Transfer generated $2 billion of cash in the first quarter, enough to cover its distribution with $965 million to spare. That gave it money to fund its growth capital projects and strengthen its balance sheet (its leverage ratio is on track to be at the lower end of its 4.0 to 4.5 times target range).
The company's growing earnings and financial strength drive its target of growing its distribution by 3% to 5% per year. While Williams and Oneok have lower leverage ratios and similarly strong dividend coverage, it's not enough to justify such a wide valuation discount, especially since Energy Transfer is one of the biggest players in the midstream sector.
Cheaper valuations drive up their income yields
Many investors aren't willing to deal with the tax hassles of investing in limited partnerships. That's weighing on these partnerships' valuations and driving up their distribution yields. This means investors willing to put up with the tax complexities can collect a lot more income by investing in these partnerships.
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Matthew DiLallo has positions in Brookfield Infrastructure, Brookfield Infrastructure Partners, and Energy Transfer. The Motley Fool recommends Brookfield Infrastructure Partners and ONEOK. The Motley Fool has a disclosure policy.
