Brookfield Business Partners: This Growth Stock Is Priced At A Tremendous Discount

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About: Brookfield Business Partners L.P. (BBU)
by: Canadian Dividend Growth Investor
Summary

Brookfield Business Partners has +30 years of proven track record in investing and managing businesses on a global basis.

It aims for returns of 15-20%.

Buying the stock on big corrections can lead to even higher returns for you.

The risks lie in the strong reliance on management competency and the limited partnership having volatile earnings/cash flows from buying and selling businesses. This makes it very difficult to value the stock.

Brookfield Business Partners LP [TSX:BBU.UN](BBU) was spun off from Brookfield Asset Management [TSX:BAM.A](BAM), which continues to own a large piece of the company (~68%) as well as manages and operates it.

Unlike its sibling limited partnerships, Brookfield Infrastructure Partners LP [TSX:BIP.UN](BIP), Brookfield Property Partners LP [TSX:BPY.UN](BPY), and Brookfield Renewable Partners LP [TSX:BEP.UN](BEP), BBU offers a small dividend yield and is growth-oriented. So, investors should expect strong long-term price appreciation from BBU instead of dividends.

Specifically, BBU aims for returns of 15-20% on its investments, which means that if you buy the stock on this correction, you have even greater long-term returns potential.

The chart below shows the NYSE:BBU price action since October.

Chart Data by YCharts

And here's the long-term chart price action of NYSE:BBU compared to the U.S. market, using SPDR S&P 500 ETF Trust (SPY) as a proxy. Notice that BBU is more volatile than the market -- it rallies higher but also falls harder at times.

Chart Data by YCharts

BBU's price action since it was spun off from BAM.

Despite the +25% correction, BBU has still delivered annualized returns of ~18% over the last two years or so. This indicates a strong growth stock and the helpfulness of buying at the right price to boost returns or reduce risk.

BBU graph showing total returns over the last 2 years Source: FAST Graphs

What Does BBU Do?

BBU acquires high-quality businesses that are either market leaders or are businesses that it can improve on by applying its global investing and operational expertise. Ultimately, BBU believes that the businesses that it acquires will generate strong cash flow -- if not now, then in the future (after it improves the operations). When a business has maximized its value, BBU would sell it and redeploy the proceeds in better opportunities for higher returns.

A key advantage of BBU's business model is that it has the flexibility to invest in any form. This means it can acquire businesses outright, make loans to them, or acquire debt and equity securities in businesses when they become mispriced. These are the kinds of investments that retail investors may not have access to or the expertise to invest in. And this makes BBU an excellent addition for investors looking for growth.

BAM has been in this line of business -- sourcing for global opportunities, and investing and managing businesses -- for more than 30 years with a proven track record. So, shareholders can be assured that their money is in good hands.

2018 Results

BBU's net income improved markedly from $24 million in 2017 to $422 million in 2018. This indicates that BBU can have volatile earnings. Sometimes, BBU even buys businesses that are losing money can deliver strong returns after BBU works its magic on it.

BBU also observed strong cash flow growth at all its business segments. This resulted in an overall 155% growth in funds from operations ("FFO") on a per-unit basis.

Pie chart on BBU showing its 2018 FFO diversification Source: Company data - BBU's FFO diversification in 2018

The Industrials segment increased FFO by 188% to $470 million compared to 2017. Selling businesses when the value is maximized is a normal course of action for BBU. In Q4 2018, by selling a business, BBU boosted its Industrials segment FFO by an $82 million after-tax gain. In 2017, BBU sold two businesses in this segment for net gains of $66 million.

The Infrastructure Services segment increased FFO by ninefold to US$195 million compared to 2017. This segment comprises Teekay Offshore, which provides services to the offshore oil production industry, and Westinghouse, which BBU acquired in August 2018.

Teekay performed better than 2017 and also got a one-time settlement payment from a customer. Westinghouse is a leading global provider of infrastructure services to the power generation industry. It has performed well since acquisition and management continues to work on the business to enhance its profitability.

Business Services segment increased FFO by 42% to US$131 million compared to 2017. This segment consists of services business across a range of sectors including a construction services business, a facilities management business, a real estate services business, a gaming business that it acquired in Q1 2018, and others. New business activity remains strong, as indicated by its backlog of ~$8 billion at the end of 2018.

Growing the Business

In 2018, BBU invested $480 million (or $1.2 billion with institutional partners) in acquisitions. It also capitalized on investments for gross proceeds of $1.5 billion. At the end of the year, the company had ample liquidity -- $2.2 billion, including $1.3 billion of undrawn credit capacity -- for investment.

BBU has the connections and capital power to go after multi-billion transactions that many others can't. For example, in November, BBU (together with institutional partners and Caisse de dépôt et placement du Québec ("CDPQ"), an institutional investor) announced to acquire Johnson Controls’ (JCI) Power Solutions business for $13.2 billion. This acquisition is expected to close in mid-2019.

The transaction will be funded with ~$3 billion of equity (roughly 1/3 from BBU, 1/3 from institutional partners, and 1/3 from CDPQ) and ~$10.2 billion of long-term debt financing. BBU expects the business' strong cash flow generation will pay down the debt over time.

The Power Solutions business makes batteries for global automakers and aftermarket distributors and retailers for use in almost all types of vehicles, including hybrid and electrical models. It’s believed to be a durable business that generates largely stable cash flows -- roughly 75% of the business' profitability is driven by non-cyclical aftermarket sales.

In January, BBU announced that it will acquire Healthscope, for $4.1 billion, with its institutional partners. Healthscope is a market leader. It is the second largest private hospital operator in Australia and the largest pathology services provider in New Zealand. It operates 43 private hospitals across Australia and 24 pathology labs across New Zealand. Its long-term track record of stable growth is expected to continue. The transaction is expected to close in Q2 2019.

Investor Takeaway

BBU is trading at a cheap P/E and P/OCF of 10.3 and 1.6, respectively. However, it's difficult to value the company because its earnings/cash flow generation can be volatile due to its acquiring and selling businesses.

Additionally, it'd also consider buying businesses that are not profitable -- believing that it can use its operational expertise to improve the operations and generate strong profitability and cash flow in the future. So, there's a heavy reliance on management competence. If BBU buys a business that isn't as good as planned or BBU takes too long to improve a business, there can be a big hit on the stock.

All that's left is for investors to buy the stock when it corrects. Now I believe is that time.

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Disclaimer: This article consists of my opinions and is for educational purposes only. Please do your own research and due diligence and consult a financial advisor and or tax professional if necessary before making any investment decisions.

Disclosure: I am/we are long BAM, BBU, BEP, BIP, BPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm long on the TSX: BAM.A, BBU.UN, BEP.UN, BIP.UN, and BPY.UN.