The Motley Fool

A Special Report

5 TSX Stocks to Soar in 2020

Fellow investing Fool,

Thank you for joining us and we’re thrilled that you’re on board! My name is Iain Butler, and I’m the Chief Investment Advisor of Motley Fool Canada.

You’ve made a wonderful step towards achieving your financial goals, and having some fun along the way, and I can’t wait for you to get started. Before you jump into the service, however we’ve prepared a special report for you.

I don’t necessarily classify myself as any one “sort” of investor, but I do recognize the importance of mixing things up. For me, I think this report does a great job of capturing what this means.

Included are, what I believe to be, a collection of highly attractive opportunities pulled from investing’s most classic disciplines: growth, income, and value.

Now, of course, I can’t promise that these selections will go up, down, or sideways. However, I do sincerely believe that in concert, investing in these five selections will leave you well-positioned to expand your net worth, regardless of what the market throws at us over the next 12 months, or years(!).

I won’t keep you from learning more about each of these companies, and the rest of our recommendations any longer.

Here’s to growing richer, together, over the years to come,

Iain Butler, CFA
Chief Investment Advisor, Motley Fool Canada

 


TOP STOCK: Shopify (TSX:SHOP)(NYSE:SHOP)

Shopify’s e-commerce platform allows merchants of all sizes to build an online presence, including storefronts and fulfillment, payment, and shipping services. (It’s also one of our 10 Starter Stocks 2020.)

Why Buy:

  • Founder Tobias Lutke continues to lead Shopify as chairman and CEO, and he has retained a sizable 8% stake in the company.
  • Shopify’s addressable market continues to grow as e-commerce captures a larger share of overall shopping.
  • Volatility has brought the stock’s price a little lower lately, but its fundamental long-term prospects remain promising.

Frankly, up until yesterday morning, I had a completely different company in mind for this month’s Canadian recommendation. Then I went through Shopify’s quarterly release, and the company in mind simply fell by the wayside. Call me a sucker for continued greatness, but it seemed outright illogical not to add to our exposure after reading the report/conference call (and yes, I came to this determination before this post was shared in the forums—though it didn’t hurt).

To be sure, this is an “add-to-your-winners,” David Gardneresque special, but it was through his lens that we recommended Shopify in the first place—a move that we’ve been rather pleased with.

Let’s first go into some quarterly observations, and then we’ll zoom in on the business itself—one that we understand far better than we did when that original recommendation was made, even though it continues to evolve at warp speed.

Catching Up With a Ferrari

To be sure, 2018 was another bang-up year at Shopify, and the fourth quarter was no exception. All of the spectacular growth metrics that we’ve come to know were on full display, and we’ve a company that continues to fire on all cylinders.

Digging in a bit, Shopify has grown to this point largely on the back of its success with small and medium North American businesses that are building an e-commerce presence. This continues.

However, the company’s future growth channels are really beginning to take shape.

Shopify Plus, which is a more involved suite of offerings tailored towards bigger businesses that have either graduated from the more basic (lower-priced) Shopify offering or signed on direct. The year ended with 5,300 merchants on the Shopify Plus platform, up by nearly 50%, with launches in the fourth quarter from a wide variety of verticals: consumer packaged-good companies like Johnson & JohnsonUnileverProcter & Gamble, and General Mills; iconic fashion houses Steve Madden, Nicole Miller, and Jones New York; more traditional fashion retailers like Wet Seal; sporting good companies like Spider Ski Wear, Craft Sports, Helen Nocks, and Specialized Bicycle.

Heck, even a merchandise store for the wildly popular video game Fortnite launched on Shopify Plus. (Shopify as a play on e-games? Hey, it fits the bill for marijuana exposure.)

Indeed, more than half of the new Plus merchants in the quarter are brand new to Shopify—an indication that the word is out, and more and more large-scale merchants are seeking out Shopify for the first time. Looking to build on this, Shopify has set aside $30 million for brand-building purposes in the year ahead. The company notes that its astronomical growth has occurred despite having very low brand awareness—a dynamic I might anecdotally second based on the frequent “Shop-a-what?” responses I get whenever I toss this name into the air during social gatherings (this could be a function of the low-brow folk I associate with, though).

A brief interlude along these lines. I cut my teeth in this industry during the Nortel era and grew up during Research in Motion’s rise and fall. You’d better believe both come to mind when I consider this situation. It wouldn’t surprise me if you’re the same, with the natural “and we all know how that turned out” that follows.The thing is, there are significant differences. Part of the reason I’m so confident that Shopify’s best years are still well into the future is that this company isn’t even close to where either of those two companies were in terms of a) size (just a $20 billion market cap) and b) hype. Aside from my social circles, our forums are another indication of the latter. Look no further than the attention given to pot stocks over the past year vs. Shopify, both in terms of volume and tone. It’s rather easy to tell where the hype component has existed.

The company’s other fast-emerging growth channel is international: an initiative that only began in 2018, despite Shopify’s existing, somewhat accidental international presence.

Step one involved translating the platform, which is now available in seven languages: English, German, Japanese, French, Spanish, Brazilian Portuguese, and Italian. In addition, with the launch of Shopify Payments in Spain, this important component now reaches 11 countries: the U.S., Canada, United Kingdom, Australia, Ireland, New Zealand, Japan, Singapore, Hong Kong, Germany, and Spain. Key markets have been targeted for investment, and if the uptake we expect occurs, this international initiative alone could satisfy our growth cravings for years to come.

Drilling Down

Underlying these relatively new pursuits, Shopify’s legacy business continues to crank away in the background. This, Fools, is where the guts of the story reside and where the company’s true competitive advantage lives.

You see, offering a platform upon which to conduct e-commerce is relatively simple. I mean, I couldn’t do it, but other platforms certainly exist. How Shopify has managed to emerge from the pack, and continually extend its lead, is because of the ecosystem that has evolved around this relatively straight-forward e-commerce platform.

Toiling away, largely independently, is a network of 20,000 or so app developers and agency partners, all singularly focused on creating tools that help the businesses that launch and exist on Shopify’s platform sell their goods and services. At the end of 2018, this collection of developers and partners had stocked the company’s app store with about 2,500 apps, which, just like Apple, are available for purchase by the company’s merchant customers.

This emerging ecosystem has led to a powerful network effect within Shopify and an increasing competitive advantage. As more merchant’s garner success with the help of these apps, more merchants join the platform, which, in turn, attracts more developers and partners that develop more useful apps. And so on.

It’s upon this ecosystem, churning away, that the company intends to build the growth channels discussed earlier. That’s combined with the ongoing success of its legacy business, which is by no means anywhere close to finished.

Risks and Considerations

The biggest risk we perceive has little to do with the company. And almost everything to do with our brains.

You see, as Shopify gathers the hype that we suspect it will, this is going to become a really loud stock. We’ll get back to this in a second but, heck, trading at the multiple at which it trades, we’re already dealing with a stock that is going to be volatile. I can’t stress this enough.

Therefore, the only circumstance under which you should follow this recommendation is if you’re not just prepared for this volatility but also committed to owning this company for the next five years. There’s no sugar coating this: I fully expect this recommendation to be under water for periods of time, and without this commitment, it’s very likely to cost you—significantly and unnecessarily.

That leads to another consideration. If you’ve owned Shopify since our original recommendation, there’s reason to believe it’s a relatively big position in your portfolio. Be wary of this. We’re effectively taking our exposure here in Stock Advisor Canada to 4% of the Canadian side of the Scorecard. Personally, I’ve a position that’s much larger than this that, frankly, I won’t be adding to. At least right now. This doesn’t mean I’m talking out of both sides of my mouth here; it’s just that there’s a portfolio management dynamic involved with every idea we put forward, and I want to make it especially clear in this case.

If we focus on the business, Shopify is very much reliant on a buoyant North American economy. For now, anyways, until international becomes more significant. Since it’s hit its stride, and certainly since it’s existed in the public realm, there has been an economic tailwind. And I suspect that the telegraphed downdraft we mentioned will occur when the North American economy rolls over. You’re obviously free to try and time this, but I suspect you’ll get it wrong, which is why we suggest at least starting a position and mentally preparing for this inevitability.

Finally, let’s swing back to valuation. We’re dealing with a company that currently trades at 20 times sales—again, a big reason why volatility has to be expected. The way we see this playing out, however, is that when February 13, 2024, rolls around, and Shopify’s sales are orders of magnitude higher than they are today, the multiple based on today’s stock price will look like a total bargain.

To demonstrate, we first recommended Shopify in September 2016, when it traded at 13 times sales—not cheap by any stretch. However, given today’s sales that amount to about $10 per share, the multiple we effectively paid amounts to just 3.5 … for a company growing at more than 50% annually. Now that is cheap.

This is the exact scenario we foresee playing out over the next half-decade with the cost base associated with this recommendation. Today’s multiple of 20 will look like a bargain in the years ahead.

Foolish Bottom Line

One look at Shopify’s price chart, or the return associated with it on the Scorecard, and I totally get how it’d be one that you find easy ignore. If you have a five-year horizon like we do though, you do so at your own peril.

Given our level of comfort with this company has increased as it has, I’m probably keener to be putting it forward today than I was when it was a still relative unknown back in 2016. And when we think of the ground the company has covered since that original recommendation, it’s rather breathtaking. Fools, now with much of the developed world in focus, Shopify could just be getting started. Don’t be distracted by where we’ve been. Get out your blinders and at least begin a position in this great Canadian company.

Disclosure: Write-up date: 2/13/2019. Iain Butler owns shares of Shopify. Tom Gardner owns shares of Shopify. David Gardner owns shares of Apple. The Motley Fool owns shares of Apple and Shopify.

 


 

 Alimentation Couche-Tard (TSX:ATD.B)

A convenience store consolidator and operator that has been growing by acquisitions and expanding globally. It learns from its acquisitions and applies the best practices across its operations.

Why Buy:

  • It has a leading position in North America and parts of Europe.
  • A Foolish management team with demonstrated excellence in capital allocation — making strategic acquisitions, deleveraging, generating strong free cash flow, and growing its dividend at a high pace.
  • It is in its early stages of international expansion with lots of growth runway. The next key area of growth is in the Asia-Pacific region.

If you’re walking around your neighbourhood or exploring a new culture on a trip to Ireland, China, or other parts of the world, and you get hungry, you may very well find one of Alimentation Couche-Tard’s (TSX:ATD.B) convenience stores near you, for a quick bite, as many of its sites offer much more than just fuel for your vehicle.

The Business

Couche-Tard is a global convenience store consolidator and operator. It has a leading position in Canada, the United States, and parts of Europe — the Scandinavian countries (Norway, Sweden, and Denmark), the Baltic countries (Estonia, Latvia, and Lithuania), and Ireland. Many of its locations also have road transportation fuel dispensing.

The company has grown by acquiring fitting companies and extracting significant synergies from the acquisitions. It also learns from the acquisitions and applies the best practices across its platform. Couche-Tard’s fuel stations help attract foot traffic for its higher-margin categories that it focuses on growing. For example, it just introduced bean-to-cup coffee machines with seasonal blends and limited-time flavors at 5,500 stores in the U.S. and have seen positive results.

In October, Couche-Tard reported having 9,815 stores in North America, of which 88% had road transportation fuel dispensing, 2,708 stores in Europe (including Poland and Russia), and about 2,280 licensed stores in 16 other countries and territories, such as Mexico, Indonesia, Hong Kong, and Vietnam.

Couche-Tard attracts its customers by aiming to offer fast and friendly service for time-hungry consumers. It also offers a variety of product offerings, which are often localized, including food, hot and cold dispensed beverages, car wash, private labels, and fuel.

Furthermore, Couche-Tard is exploring new technologies to add value and make things easier from the backend to the frontend. These technologies include cloud services, the Internet of Things, the electrification of vehicles, and others.

Here’s a specific example. Couche-Tard began using Norway as a laboratory for the electrification of vehicles in 2017. It was the perfect place to test the waters because Norwegians love driving their electric cars. Recent electric car sales were roughly 60% of all auto sales in Norway!

Couche-Tard now has +360 fast chargers in the country with 64,000 charge sessions in August. While customers wait for the charging to complete, they’re encouraged to spend more at the stores. As Couche-Tard has gained the experience from Norway, it will have a clear advantage when it deploys chargers in North America, which has had slower adoption for electric vehicles.

Track Record

Since opening its first store in 1980 in Quebec, Couche-Tard has aggressively expanded its empire with an unwavering discipline to pay down its debt before moving on to the next acquisitions that make a good fit.

Couche-Tard has made about 60 acquisitions since 2004. In the past three years alone, the consolidator made 10 acquisitions, involving more than 3,000 stores.

It has the knack of juicing out synergies from its acquisitions. For example, Couche-Tard aimed for synergies of $150-200 million for the Statoil acquisition in 2013; it achieved more than $200 million for the top Scandinavian convenience and fuel retailer that had over 100 years of operations in the region.

A more recent example — for the CST Brands acquisition, Couche-Tard estimated synergies of $150 million and boosted the target to $215 million later on.

Couche-Tard has a track record of growing its profitability. Its recent results have been nothing short of super. In the past five years, its gross profit, EBITDA, and free cash flow have increased at a compound annual growth rate of more than 13%, 17%, and 16%, respectively.

The convenience store leader’s strong profitability has allowed the shareholder-friendly company to increase its dividend per share every year since 2007 with a compound annual growth rate of 28%, and its payout ratio is still only about 22%. So, don’t be discouraged by its small yield. Using the Rule of 72, we can approximate that its dividend will double in about five years if the dividend grows at a rate of 15%.

The Opportunity

Early on in 2003, Couche-Tard had the foresight to obtain the easy to remember Circle K brand from ConocoPhillips. After about 40 years of acquisitions and expansion, Couche-Tard has decided to convert its umbrella of brands (except for the Couche-Tard stores in Quebec) to the Circle K brand, which was already recognized internationally in 14 countries outside of North America and Europe.

Couche-Tard updated the Circle K logo to have a cleaner, fresher, and more relevant design to make it the go-to convenience brand around the globe. It’s taking on a pragmatic approach to rebranding its stores to the Circle K brand as a part of its normal cycle of store refreshes.

Entering the fourth year of its Circle K rebranding project, the company has fully completed the store conversions in Europe and is more than 80% complete in North America.

Some key advantages come with the unified Circle K brand, including increased brand awareness, leveraging its scale across procurement, and the ability to launch marketing campaigns across the nation. For example, in the U.S., Couche-Tard rolled out Easy Pay, a loyalty and discount program for fuel that encourages repeat visits.

The conversion to the modernized Circle K brand will be a fabulous start for further expansion internationally in the fragmented industry, including in North America and Europe, but particularly in the Asia-Pacific region.

After the transformative acquisition of CST Brands in 2017, juicing out synergies, and bringing down debt levels, Couche-Tard is ready to pounce on another awesome acquisition — this time Australia’s Caltex, the largest fuel and convenience chain in the country.

As of writing, Caltex and Couche-Tard are still at the bargaining table — so far, Caltex has rejected two of Couche-Tard’s offers with the last bid worth $7.7 billion. Regardless of how this goes, Couche-Tard has identified multiple acquisition opportunities in the area. Couche-Tard is a disciplined acquirer; if worse comes to worst, it may just have to revisit this acquisition in the future.

Management

Couche-Tard offers a truly long-term Foolish management team, which has created tremendous wealth for its long-term shareholders. Co-founder Alain Bouchard was Couche-Tard’s CEO and President for 25 years until September 2014 when Brian Hannasch took on the leading roles of CEO and President. By 2014, Couche-Tard already had strong positions in Canada, the U.S., and parts of Europe, as well as some international presence.

Hannasch had joined the company in 2001 and had played in multiple senior executive roles, such as COO and Senior Vice-President of U.S. Operations. He continued Couche-Tard’s acquisitive culture with acquisitions, such as The Pantry in 2015 and CST Brands in 2017, which further strengthened Couche-Tard’s leading position in the U.S., as well as Topaz, the leading convenience and fuel retailer in Ireland, in 2016.

Management knows where to allocate its capital. Return on equity averaged 22.7% over the past 10 years, through slow economic growth, economic expansion, and myriad acquisition integration.

Valuation

Revenue grew about 9.3% per year over the past five years, but Couche-Tard translated that to diluted earnings per share growth (based on GAAP earnings) of 17.8% per year and free cash flow per share growth of 16.5% annually. This strong profitability was thanks partly to operating margin expansion from 2.7% to 4.2% from five years ago.

The growth stock has run up nearly 43% (split-adjusted) since we recommended it about a year ago as one of the top stock ideas for 2019. The stock’s price-to-earnings multiple has since expanded from about 16 to 19.5 as the business carried on doing its mojo. This is still a reasonable valuation for Couche Tard given its consistent double-digit growth. However, after the run up, we wouldn’t be surprised if it decides to hang around at the low $40s level for some time.

The Foolish Bottom Line

As a long-running compounding entity with ample opportunities to further consolidate the fragmented space on the global stage, Couche-Tard still has lots of growth runway.

As Charlie Munger taught Warren Buffett, a great business at a fair price is superior to a fair business at a great price. Couche-Tard is certainly the former.

Disclosure: Write-up from 12/2/2019. The Motley Fool recommends shares of Alimentation Couche-Tarde.

 


 

 BlackBerry (TSX:BB)(NYSE:BB)

BlackBerry operates as a security software and services company in securing, connecting, and mobilizing enterprises worldwide.

Why Buy:

  • The company’s increasingly expansive platform continues to generate multiple wins.
  • BlackBerry’s seemingly weak financial performance has masked the emergence of its Software and Services business.
  • Strong, experienced leadership has already put the company in a leadership position from which it can grow or possibly find an acquirer.

Frankly, a BlackBerry (TSX:BB) re-recommendation here in Stock Advisor Canada has been a matter of “when,” not “if”—especially as we’ve gotten to know the company better and seen it evolve as it has since our original recommendation in December 2017.

The market had a heck of a rally to kick off 2019, BlackBerry included, but that’s reversed since then. This has left us with a price we just can’t turn down.

Do we regret not putting BlackBerry forward as it swooned along with the rest of the market to close 2018? Only time will tell. We feel pretty good though about the recommendations that we made during that stretch and there was a lot more competition for our love. Now, though, as we expressed last week, we’re still left with a company trading for less than it did when that original recommendation was made, yet BlackBerry is so much further along than it was. To be sure, it remains early days for this company’s full reset, but the fog has begun to lift on what we believe will turn into a very sunny future.

The story/thesis is largely as it was, so I suggest you go back and read the original. But let’s run through some updates and further insights into what continues to be a wonderful resurgence.

Catching Up With a Former Legend

A look through BlackBerry’s recently released Annual Information Form is highlighted by all the company accomplished in fiscal 2019. We’ll touch on several of these developments, but there are none greater than CEO John Chen’s declaration that the half-decade-or-so-long transformation from hardware to software company is now complete.

After the company’s financial position, which had moved into a rather precarious position, was secured, this strategic transformation was next on Chen’s overarching to-do list. With it complete, the company is squarely on the offensive—ready to grow from here.

Another significant accomplishment from fiscal 2019, and something that we expect will help fuel future growth, was BlackBerry’s acquisition of Cylance. There’s good reason to believe we’re going to look back on this $1.4 billion move as a very favourable development in the years ahead.

CylancePROTECT and CylanceOPTICS are endpoint threat-prevention solutions that jive very nicely with the rest of BlackBerry’s suite of offerings and services—a collection that also includes QNX, which is a global provider of real-time operating systems used in the automotive, medical, industrial automation industries … and then some. QNX has had especially dramatic uptake in the automotive industry—something we expect will continue.

These are different offerings but, brought together under the same roof, have the potential to be very powerful together, which nicely illustrates a theme that has underlined BlackBerry’s revival. As we indicated in our initial recommendation, BlackBerry has leveraged its past success to cobble together an extensive suite of software-rooted services, all of which are related to what the company terms the “Enterprise of Things.” Servicing the Enterprise of Things is the company’s focus and where it expects to employ its collection of productivity and security innovations, with endpoint management and security of primary importance.

While the company’s past is forever tied to the mobile e-mail devices that anyone over, say 25, is no doubt rather intimately familiar with, underlying these historic devices was a suite of technology that we expect will prove more valuable than most currently think in the years ahead. Continuing to leverage this significant core asset, both organically and by way of complementary acquisitions, is how we expect BlackBerry to proceed from here.

The Psychological Allure of BlackBerry

Even though the company’s list of annual accomplishments continues to grow and gather momentum, if one were to simply pull the company’s financials up, they’d miss almost all of what we just described.

On the surface, BlackBerry continues to look like a mediocre company—at best. The top line has declined every year since 2011 and fiscal 2019 revenues of US$904 million are back to where they were in 2005. In addition, the bottom line isn’t anything to get overly jazzed about either. Though the perpetual losses that took hold have been stemmed, BlackBerry earned less than $100 million (or $0.17 per share) in fiscal 2019—down from $405 million in 2018 and $3.4 billion in 2011 ($6.36 per share).

In our opinion, though, the smoke screen caused by these figures is a big part of BlackBerry’s allure. To properly interpret these figures, you need to understand the strategic shift that’s occurred. And if there’s one number that summarizes this evolution, in my opinion, it’s gross margin (gross profit/total sales).

More specifically, it’s the fourth-quarter 2019 gross margin of 81.2%. Over the company’s life, which has largely been in the form of a hardware device maker, this figure has averaged 45.5%. And only once in this lifetime, the third quarter of 1996, when the company was but a pup, has gross margin ever exceeded this fourth-quarter print. This, Fools, is what strategic change looks like—change that involves a higher margin, more recurring stream of revenues as a software provider than was ever achieved in years gone by.

Arguably, today’s BlackBerry is already a better business than it ever was. What matters from this point forward is how the company grows this software-and services business that has risen from the ashes.

Risks and Considerations

One of the biggest risks cited in our original recommendation was Chen’s tenure. This risk was put to bed, at least through 2023, about a year ago. Chen’s term should suffice to help kick this company’s growth into gear. That Chen’s deal includes significant rewards related to a higher stock price is icing on the cake.

Leadership remains a critical piece of this puzzle, as even though the worst of times are now in the rear-view mirror, there is work ahead to really get BlackBerry humming. This will not come easy, and indeed, competition is significant. We’re of the mind, however, that the risk/reward scenario on offer is well worth it.

Foolish Bottom Line

Not every turnaround works, but BlackBerry has already become a leader in enterprise mobility management by leveraging its security DNA. This company has spent the last five years under CEO John Chen honing its new focus and is now at the stage where forward momentum can begin to build. Chen’s playbook, which we discussed in the original recommendation, is not yet expired.

Whether or not BlackBerry remains on its own or is ultimately acquired, we expect it to continue expanding its capability and reach in keeping connected “things” safe and secure. The best part is that many investors can’t see the green shoots growing from the rotten fruit of a decade past. We’re keen for another slice and suggest you either begin building or add to a position that you’re willing to stand by, at least over the remainder of Chen’s extended contract.

Disclosure: Write-up from 4/10/2019. Iain Butler owns shares of BlackBerry. The Motley Fool owns shares of BlackBerry.

 


 

Brookfield Infrastructure Partners (TSX:BIP.UN)

Brookfield Infrastructure owns and operates a collection of irreplaceable infrastructure assets all over the globe. (It’s also one of our 10 Starter Stocks 2020.)

Why Buy:

  • Management has armed the company with a record level of liquidity at a time when they expect opportunities to arise.
  • A high-quality pipeline of $2.5 billion worth of organic projects is currently being pursued.
  • The financial backing provided by the Brookfield family is (and remains) second to none.

Similar to other Brookfield businesses, Brookfield Infrastructure Partners (TSX:BIP.UN) is a partnership effectively controlled by Brookfield Asset Management (TSX:BAM.A) which owns 60% of the units outstanding. Brookfield Infrastructure, or BIP for short, is BAM’s primary vehicle for investing various infrastructure assets around the world.

A recommendation in multiple services, Brookfield Infrastructure appears to be set up well moving forward with M&A (mergers and acquisitions) activity picking up, along with solid organic growth to help push its bottom line higher. With a strong reputation for effectively allocating capital and improving the underlying operations of its assets we believe Brookfield Infrastructure can serve as a foundational addition to most Canadian portfolios.

The Business

Brookfield Infrastructure Partners is a publicly traded partnership which owns a portfolio of income-producing infrastructure assets. Since its spin-off from Brookfield Asset Management in 2008, BIP has invested more than $8 billion to build its infrastructure portfolio, which is diversified by asset type and geography. The assets generate stable, recurring income with roughly 95% of adjusted EBITDA regulated or under long-term contracts.

The infrastructure assets are split into four operating segments: Utilities, Transport, Energy and Data Infrastructure.

The Utilities segment is comprised of BIP’s regulated transmission lines which include 2,000 kilometers of natural gas pipelines in Brazil and 2,200 kilometers of electricity transmission lines in North and South America. The segment also includes its regulated distribution business which includes around 6.6 million natural gas and electricity connections in the UK and Colombia. In addition, BIP co-owns one of the largest coal export terminals in Australia. In all, its Utilities segment generates roughly 35% of total funds from operations (FFO).

The Transport segment includes BIP’s ownership stakes in railroads, toll roads, and ports. The company’s rail assets include over 5,500 kilometers of track in the southern half of Western Australia which is under a long-term lease with the State Government. Also, BIP operates 4,800 kilometers of track in Brazil, and recently agreed to acquire Genesee & Wyoming (NYSE:GWR) and its sizable position in the U.S. The company also owns and operates a network of toll roads in Chile, Brazil, Peru and India, and 37 port terminals located in the UK, North America, Australia, and across Europe. In all, its Transport segment generates roughly one-third of BIP’s total funds from operations.

The Energy segment includes BIP’s natural gas midstream assets and storage facilities, along with the newly acquired HVAC business from Enercare. The company’s midstream assets include roughly 16,500 kilometers of natural gas transmission pipelines in the U.S. and India, 13 natural gas processing plants, and 1,200 kilometers of gas gathering pipelines in Canada. Its energy assets also include 600 billion cubic feet of natural gas storage in the U.S. and Canada, and the residential water heater and HVAC business in the U.S. and Canada obtained in the acquisition of Enercare last year. In all, BIP’s Energy segment generates roughly one-quarter of the company’s total funds from operations.

Last but certainly not least, is the company’s Data Infrastructure segment which is expected to nearly triple in size from 2018-2020. Assets within this segment center around data transmission, distribution and storage. The company co-owns roughly 10,000 kilometers of fiber assets and 7,000 towers and active rooftop sites in France making it the leading independent tower operator in the country. In addition, the company owns 49 data centres located in the U.S., Brazil and Australia.

Recently, Brookfield announced two deals which will help expand the Data segment. Last month, it closed on a $200 million deal for Vodafone New Zealand, a nationwide wireless and fiber network. It followed that up with the announcement that it had agreed to acquire 130,000 communication towers from one of its strategic partners in India for $400 million. We like both deals, but are particularly excited about the towers in India. These recently built, high-quality assets have the potential to drive organic growth by adding new tenants, and come at an attractive price. In all, the Data Infrastructure segment generated just 5% of total funds from operations in 2018, but with the new additions it’s expected to reach 10% by 2020.

Why Buy

With any asset-based investment, the ability for management to effectively allocate capital with the intention of increasing shareholder value is critical. Thankfully, we have the folks at both BIP and BAM at the helm. The folks at Brookfield are well known for their disciplined, value-based approach to investing. Importantly, management targets, and does a solid job of delivering, returns on invested capital of 12% to 15% on its investments.

Management’s capital allocation chops will play a big role in the near-term success of the company as it executes a large-scale capital recycling program. The company has spent the past decade amassing its infrastructure portfolio, and at this stage there’s mature assets worth marketing. Brookfield kicked the process off last year when it sold its Chilean electricity business for $1.3 billion. In turn, Brookfield took that cash and invested in a number of higher-yielding and higher growth assets. This was most evident in its data centre acquisitions from last year, and recent deals for towers in India and the integrated telecom business in New Zealand.

Brookfield also targeted the energy midstream market in the U.S. last year with its purchase of natural gas gathering and processing assets from Enbridge. We expect management will revisit this market in the not too distant future as companies seek to simplify their MLP corporate structures in the U.S. In addition, Brookfield Infrastructure entered the residential water heater and HVAC business in N. America with its acquisition of Enercare last year. This year, the company added another Energy asset with the recent acquisition of a natural gas pipeline which runs from Texas to Mexico. In all, BIP has invested approximately $2.8 billion over the past 18 months in a variety of assets.

We expect the rapid pace of transactions to continue as Brookfield seeks to raise an additional $700 million through asset sales by the end of the year, and another $1.0 to $1.5 billion in 2020. Meanwhile, its deal pipeline remains quite active with management guiding for an additional $1.3 billion worth of acquisitions by year-end. We like management’s decision to take advantage of the current environment allowing it to secure attractive prices for some of its more mature assets, while reallocating that capital into higher growth assets with going-in FFO yields in the 12%-plus range.

At the same time, internal growth has been solid with organic growth rates of 10% in each of the past two quarters. We expect more of the same going forward driven by recently commissioned projects, along with modest volume and pricing gains. Given the healthy backlog of additional capital projects which now stands at $2.2 billion, the organic growth outlook appears solid.

This combination of external and internal growth should lead to solid cash flow growth. Funds from operations, on a per unit basis, are expected to grow around 10% this year, followed by 15% in 2020. With the stock currently trading for roughly 16 times this year’s projected AFFO (adjusted FFO), and 14 times next year’s projections, we think we’re getting a reasonable price today.

The Dividend

Brookfield Infrastructure raised its quarterly distribution by 7% in February to $0.50 per unit. Since its spin-off, Brookfield has grown its distribution per unit by an average of 12% annually. Moving forward, we think distribution growth will trend a bit lower, between 5% to 10% per year.

As you’ll notice in the table below, AFFO per unit growth stalled a bit last year leading to a rise in Brookfield’s payout ratio. Although, as the dust settles on its latest round of acquisitions, we expect BIP’s payout ratio to settle back down into the mid-80% range. We think BIP’s distribution is well-covered given Brookfield’s unique access to capital, and the upcoming impact from newly acquired assets and recently commissioned projects.

US$ 2015 2016 2017 2018 2019E 2020E
AFFO/unit $1.95 $2.09 $2.46 $2.48 $2.72 $3.13
growth 7.2% 17.7% 0.8% 9.7% 15.1%
Total Distributions/unit $1.62 $1.80 $2.12 $2.36 $2.50 $2.69
Payout ratio 83.1% 86.1% 86.2% 95.2% 91.9% 85.9%

Source: Company filings; analyst estimates

Risks

Brookfield Infrastructure owns and operates heavily regulated assets in a number of different countries. This exposes the company and investors to various regulatory and geopolitical risks. In addition, the company faces the potential for foreign exchange swings which could impact its results reported in U.S. dollars. For instance, the company has a sizable business in S. America where sizable currency swings are more common. Management does put on strategic hedges from time-to-time to help mitigate this risk.

By its nature, Brookfield does large, complex deals in some markets which can be rather illiquid. Over time, Brookfield’s strong reputation has led to the company largely getting the “benefit of the doubt” with regard to its M&A deals. Once again, analysts are expecting big things to come from this round of capital recycling. This can put some pressure on the company to meet its targets post-acquisition. Given the amount of M&A activity underway, there’s certainly potential for a misstep or two. If the per unit growth fails to materialize, or comes in well below expectations, we could see the stock take a hit here in the near-term. BIP will always have deal risk, but the heightened level of activity recently certainly raises this risk in the near-term.

Over the long run, we’re looking to avoid any major geopolitical or regulatory disruptions in its markets. In addition, there’s always the potential that a large deal fails to meet expectations. In each of these cases, we’re looking to avoid any sizable problem areas which could create a drag on per unit growth over a period of years.

Foolish bottom line

Needless to say, there’s a lot going on at Brookfield Infrastructure these days, and we think you should be a part of it. It’s been a long-term winner, thus far, and we see plenty more room to grow from here.

Disclosure: Write-up from 8/15/2019. The Motley Fool recommends BROOKFIELD INFRA PARTNERS LP UNITS. The Motley Fool owns shares of and recommends Brookfield Asset Management.

 


 

Stingray Group (TSX:RAY.A)

Stingray delivers music to businesses and individuals worldwide.

Why Buy:

  • Cost synergies from recently acquired NCC are running ahead of forecasts.
  • Its multi-platform model continues to gain traction.
  • Rising cash flows are tracking ahead of schedule.
  • A rising dividend, lowered debt levels, and upcoming stock buybacks make this a compelling stock right now.

With our next stock, we bring you shares of Stingray Group (TSX:RAY.A). Even though Stingray is up in the market since our first recommendation back in June, it’s rare for us to re-rec a company as quickly as we did with Stingray (only two months later!). The thing is, especially given the company’s recently reported results, we’re of the mind that there’s a pretty fantastic opportunity on offer, largely rooted in the company’s discounted valuation. Great business fundamentals and a still-attractive price justify another helping.

You see, Stingray’s business is significantly stronger than it was a year ago. Yet, it sure doesn’t seem that many realize it. With the business’s progress flying in stark contrast to how the stock has performed over the past year. If you’ve already bought some shares, we recommend you take this opportunity to up your stake. And if you missed Stingray the first time around, consider this a good time to open a position.

Indeed, if you missed the initial recommendation or have just recently come aboard the good ship Stock Advisor Canada, we suggest circling back and giving it a read. We’re going to skip the pleasantries and business description in this write-up and focus on why we’re coming back for more of a good thing.

Music to Our Ears

I (Buck here) awoke early this morning to the soothing sound of The Beatles’s “Let it Be” streaming out of my Amazon Echo. When you’re a bit jet-lagged from a recent summer holiday, the sweet sound of music can make getting up early a bit more bearable. On August 7, Stringray reported year-end results that were music to our ears.

How Did Stingray Do?  

The year-end results (reported as of the end of March) were impressive. (All numbers in CAD.)

  • Revenues grew 63% to $212.7 million
  • Recurring broadcasting and commercial revenues increased 15% to $129.3 million
  • Cash flows from operations up 124% to $44.7 million
  • Adjusted free cash flow (FCF) increased 27% to $38.8 million
  • Net loss of ($12 million)

Those are some great numbers, but they aren’t truly representative of the progress Stingray has made. There were a lot of one-time costs, and they don’t include a full year’s worth contributions from the company’s acquisition of the Newfoundland Capital Corporation (NCC) radio stations. To get a better handle at how things are shaping up for the next year, let’s take a look at the most recent quarter’s results, ending June 30.

  • Revenues up 133% to $80.4 million (annual run rate of $320 million)
  • Recurring broadcasting and commercial revenues up 10% to $34 million
  • Cash flow from operations up 264% to $26.3 million
  • Adjusted FCF up 229% to $20.6 million (annual run rate of +$80 million)
  • Net income up 582% to $9.2 million, or $.12 per share
  • Total net debt of $347 million

Those are more great numbers—an indication of what happens when a platform company starts to gain scale. Note how the bottom-line growth (cash flow and profits) is growing much faster than revenues. In addition, unlike some of the high-priced, IPO unicorns (like Uber) the share count only increased modestly. This means virtually all of the value creation accrues to shareholders—a recipe for success, Fools, when it comes to investing.

Drilling down, while the quarterly results looked great, there is more good news on the horizon. Management deserves high praise for how it’s navigated the game-changing NCC acquisition. For instance, given the addition of more established cash-generating assets (radio stations), Stingray is going to save a few million on its financing costs by reducing the interest rates on its debt. Also, the cost synergies from the acquisition are running ahead of plan. Planned operating expenses for this year are coming in lower than last year and all of that goes right to the bottom line. It’s an impressive feat, to say the least. And I dare say, you won’t find any of the freshly minted, unicorn IPOs able to grow at these rates while concurrently reducing overall operating expenses.

Stingray management is guiding toward $80 million in FCF this year, which equates to about $1.15-$1.20 per share. With shares trading just north of $7, your FCF yield (FCF per share divided by share price) on each Stingray share purchased is around 15%-17%. That’s cheap, Fool, and not an easy thing to find these days. But, with some good capital-allocation decisions, things could get even better.

Management has announced a normal course issuer bid to buyback up to 2.9 million shares of stock. Here’s what they had to say about it.

“…our interest rate is at 3.89%. So we’re paying interest rate at 3.89% and our stock is giving 4.6% dividend, nondeductible. You take an interest rate of 3.89%, after tax you’re at 2%, and we’re paying 4.6% in dividends. So on a pure cash flow basis, every time we buy $10 million of shares, we save like $300,000. So there’s a point where it becomes a non-brainer. And even more, at $1.20 (in free cash flow) per share, we’re trading at 5x sales. It generates a 20% return on investment. When we do an acquisition, our goal is to get a 20% return on investment, and in this one, we have it with our own shares. So I think it’s going to be good for the investors that we have that tool and flexibility to make more money, I guess.”

I couldn’t have said it better myself. Stingray is making more money for shareholders. That last part is what really matters to us. High growth doesn’t do much good until it flows into cash and profits. If you can grow profits and cash while also keeping your share count in check, you’re off to a great start. The next step is to allocate that growing cash hoard in a productive and shareholder-friendly way. We expect Stingray management will make bolt-on acquisitions, buy back shares, pay down debt, and support a growing dividend.

Summing it All Up

Stingray isn’t a company that’s likely to grab headlines, and its quarterly results aren’t canvassed by dozens of financial analysts. So, let’s just say the hype metre is fairly low with this company, which is just fine with us. This lack of visibility is what allows us to purchase the stock at such an attractive price. There’s no questioning the results Stingray is posting, though, and before our eyes it is growing up to be a very fine business with strong recurring cash flows. Generally, these kinds of situations will surface for the masses at some point.

As things stand, though, maybe we’ll turn to another rather famous British musician to show us the door. Mick Jagger and the gang have been known to say, “Time is On My Side”. Time has proven to be on the side of good businesses. For those who pass on purchasing shares of Stingray today, I leave you with this verse:

Time is on my side, yes it is

Time is on my side, yes it is

Now you all were saying that you want to be free

But you’ll come runnin’ back (I said you would baby)

You’ll come runnin’ back (like I told you so many times before)

You’ll come runnin’ back to me, yeah….

– The Rolling Stones

Disclosure: Write-up from 8/14/2019. The Motley Fool owns shares of and recommends Stingray Digital Group Inc.