Macquarie Infrastructure Company (NYSE:MIC) – $51.63

January 2014

Macquarie Infrastructure Company (MIC) is a long – with upside towards $70.  The underlying assets are well-positioned and strategically valuable, with visible, contracted cash flows that should drive $3.75+ of dividends in 2014.  While comps are imperfect, I believe in this environment, MIC should trade at a 5.5% yield.  Through capital appreciation and dividends, I see ~40% returns during 2014.

MIC is neither overly leveraged nor distressed, but analytically complex, with a reasonably interesting (AA leverage, IMTT distributions) history.  Pokey351’s March 2012 write-up was spot-on, and I’ll refer people there for additional background. 

Many investors associate Macquarie withAustraliaand / or terrible toll road deals, however, the MIC holding company is decidedly different.  MIC’s operating assets are as follows:

• 50% stake in International Matex-Tank Terminals (IMTT); comprised of a bulk liquid storage business and Oil-Mop International.  The storage business drives the vast majority of EBITDA, with 12 bulk liquid storage terminals in theUSandCanada
• Hawaii Gas, a regulated utility serving residential & commercial customers inHawaii
• 50% stake in District Energy, an urban, commercial cooling system inChicagoand (smaller) heating & cooling system inLas Vegas
• Atlantic Aviation, a private fixed base operations (FBO) company with slots at 63 airports nationwide
• MIC Solar, a small, but growing portfolio of solar assets, with 57MW of capacity.  Solar is not included in my tables given materiality; it just became a reportable segment in Q3 and would generate <$5mm of ‘harvest-mode’ annual FCF

While all information is publicly available and MIC trades ~300k shares daily, the analytical framework is complex, with five different operating assets (two of which are not wholly-owned).  Published, GAAP financials are confusing and the Company can screen poorly (CapIQ shows MIC @ 24x CY 2013E EBITDA).  Operating assets must be modeled individually and then proportionally consolidated.  I believe this framework is cleaner, as per the below table.

MIC’s portfolio should generate ~$505mm of wholly-owned pro forma (Galaxy) 2013E EBITDA.  There are plenty of numbers and moving pieces, so for the sake of brevity, I’ll focus on IMTT & Atlantic Aviation (>80% of proportional EBITDA).

• IMTT– comprised of a bulk liquid storage business (IMTT) and an environmental remediation firm, Oil Mop International (OMI)
  • Bulk Liquid Storage – owns and operates large (45mm barrels of capacity) liquid storage tanks in the New York Harbor (NYH), Mississippi Gulf Coast and Canada.  These facilities store Petroleum & Asphalt (62%), Chemicals (26%) and other industrial liquids.  The phrase ‘buy land, they aren’t making it anymore’ is certainly relevant when it comes to large, waterfront chemical storage facilities.
    • Facilities in the NYH bear special mention, given an enviable position in theUS’ most important petroleum trading hub.  Docks are dredged to depths of45 or 50feet, relative to 35 feet for competitors.  Large ships can unload at IMTT’s docks, whereas for competitors, they are sometimes forced to transfer a portion of their cargo to barges (lightering).  Lightering is expensive and time consuming – meaning IMTT’s products have built-in structural advantages.
    • OMI Environmental – provides environmental remediation services on the Gulf Coast.  This business is similar in nature to a private Company, in which I’ve previously invested, LVI Services.  The base business is ‘ok’, but can thrive during natural disasters (see 2010 BP oil spill-related spike).
• Atlantic Aviation– AA operates the nation’s largest FBO network (BBA’s Signature is #2), providing fuel, parking, hangar and other related services at 63 airports nationwide.  There are benefits to scale (network effects for take-off and landing, brand recognition with airports and acquisition targets) and MIC wants to grow this business.  The leases by nature are very long in duration, but the business is volatile, driven by private aircraft activity.
  • AA is by far MIC’s most cyclical and volatile asset – a risk, but we also have a tailwind (no pun intended) as flight activity improves.  Prior period EBITDA peaked at $136mm in 2008, a year that saw 4.5mm flight movements.
    • The business has grown through tuck-in acquisitions and careful management of the cost structure, bringing TTM EBITDA to $141mm.  But with 3.8mm TTM flight movements, trends are moving in the right direction and remain meaningfully below peak levels.

HoldCo / Capital Allocation / Valuation

Each asset’s debt is non-recourse to the parent, MIC, which itself is unleveraged.  The debt of Hawaii Gas, District Energy and Atlantic Aviation is consolidated, while IMTT’s debt is not.  Proportional consolidation should add and subtract 50% of the debt for IMTT and District Energy, respectively.

The cleanest way to analyze HoldCo’s cash flow is on a proportionally consolidated basis.  Once adjusted for corporate expenses & other investments (e.g. MIC Solar through FQ3 2013), we have an Adjusted Proportional EBITDA figure.  From here, we deduct proportional cash interest, cash taxes and maintenance capex (growth capex funded by specific project / subsidiary-level debt).  This Proportional Free Cash Flow figure is complicated and perhaps not 100% intuitive at first, but is real, tangible FCF.  The below table outlines Proportional FCF and provides relevant Capitalization / Valuation data.

We have TTM proportional adjusted EBITDA and FCF of $325mm and $205mm.  Note TTM figures are actuals, whereas I’ve adjusted 2013E guidance to reflect the acquisition of Galaxy Aviation ($18mm annualized EBITDA, 2.1mm shares, $90mm incremental debt).

From 2013E PF Proportional EBITDA of $352mm, I expect mid to high single digit growth, based on the following:

• Continued unbundling @ IMTT – Physical storage has become increasingly unbundled from ancillary services (docking, transportation, etc.).  So while storage rate growth has slowed, IMTT is finding additional (contracted, non capital intensive) ways to grow EBITDA
• Incremental capacity @ IMTT – Utilization rates have dipped due to two large (500k barrel) and several smaller tanks having been taken offline inMississippi.  One of these tanks was brought back online in October, with the other perhaps making a comeback in mid-2014
• Improvement in aviation trends – With 3.8mm TTM private flight movements relative to a peak of 4.5mm, the industry has the wind at its back.  No magic here, it’s a cyclical business, and that’s a good thing in this environment
  • The 5% growth rate is less than scientific, but also sets a sufficiently low bar relative to management’s expectations and historical results (TTM YoY Proportional EBITDA growth of 11%)

Puts 2014E Proportional EBITDA at $370mm:

• Incremental FCF flow-through is very high; at historical averages of 75% we’ll see $13mm of incremental FCF
• IMTT maintenance capex should normalize from elevated, Sandy-driven levels.  TTM maintenance capex of $88mm is elevated versus both longer-term averages ($45mm) and management’s 2014 guidance ($55mm).  50% of $33mm = $17mm of incremental FCF
  • The above bridge to 2014E Proportional FCF of $250-$255mm, 82.5% of which implies a $3.75 dividend

By no means am I a dividend stock expert, nor do I focus specifically on infrastructure, but I think that yield is too high, especially for a business with solid underlying growth, reasonable leverage (weighted OpCo leverage @ 3.7x) and a sustainable capital allocation policy.

Utility stocks trade at 4% yields, but MIC is no utility.  MLPs also trade around 4%, but the assets are much larger, with different operating characteristics.  With an explicit acknowledgement of ‘there is no magic yield’, I think a 5.5% target is reasonable, even relative to HY (5.7%) or historical MIC trading levels (~5%).  These assumptions get us to $68 + $3.75 or $72 total value, a 40% total return.  Viewed another way, $68 implies a $3.8bn target market cap, or 15x free cash flow.  I don’t think that’s an aggressive price for such a strong portfolio of assets.

The catalysts are not as ‘hard’ as I’d prefer, but you’re getting paid to wait.  Here is the event path, as I see it:

• Normalization of IMTT FCF – Maintenance capex has nearly doubled from pre-Sandy levels to $88mm TTM.  As repairs are completed and maintenance capex normalizes (towards $55mm) IMTT’s distributable free cash flow should grow
• Dividend Hike – When combined with normalization in IMTT capex and modest EBITDA growth, the dividend should grow towards $3.75+ in 2014
• Buy-in of IMTT Stake – While longer-term in nature, management has made no secret regarding their; (i) displeasure with IMTT’s current management team (specifically their financial planning & analysis) and (ii) desire to own the asset outright.  The growth drivers are real and tangible and as super-tankers become more prevalent in 2014 and beyond, IMTT’s relative structural advantage should improve.  Regarding aesthetics, the consolidation of IMTT should also help simplify the overall MIC story

As for the risks:

• 9/11 Risk – Both commercial and private air travel will be hurt if / when we see another act of terrorism.  Unfortunately, this is probably a ‘when’ rather than an ‘if’, but certain people are screwed up beyond repair.  Offsetting this risk, to an extent, is Atlantic Aviation’s focus on costs; both during the 2009 downturn and the more recent upswing
• Management – I’ve seen plenty of awful, Macquarie-led infrastructure deals (Indiana Toll Road, Northwest Parkway, South Bay Expressway, Chicago Loop, M6), but can say with certainty that the MIC was and is different.  Regardless, James Hooke and crew will look to grow by acquisition, and to the extent they make bad deals, we will suffer
• Macquarie Incentives– Not a new or unknown risk, but another layer of complexity.  Base management fees are paid based on market cap and blend to ~1.2% annually.  Performance fees are hedge fund-like; based on MIC’s excess return above a custom, peer-weighted benchmark (effectively MSCI Utilities). Macquariegets 20% of the spread, subject to high-water marks
  • Another hitch – the manager often gets paid in shares (versus cash, at their election).  The theoretical good (eating their own cooking) is offset by the practical bad, in that higher share counts limit dividend growth, and Macquarie-related secondaries (they target 5-10% stake) can have an odd feel (say the stock is undervalued but you keep selling shares…..)
• District Energy Refinancing – I debated the inclusion of this risk given District Energy is so small ($20mm EBITDA) and MIC only owns 50%.  But I get the sense that management likes the asset, both in theory and practice, and have had some bad luck of late (weather, customer contract termination).  DE is clearly overleveraged and they will need to contribute some equity alongside the refinancing