Investoid

Thicken My Wallet has mused about the increasing popularity in infrastructure firms. He indicates that companies like RBC are investing in the sector now and that it may become the new fad sector.

I think the infrastructure sector has a lot going for it at the moment. The continuing development of the BRIC countries as well as Eastern Europe has lead to increased demand for new capital projects to meet the needs of the increasingly wealthy populations of these nations. As a result the sector is in a cyclical growth period, one that will probably last for several years, if not a couple of decades, since most of these projects take many years to build.

One way to play this sector is to look at infrastructure services firms. I believe these companies will also benefit from this cycle, but are better value since they typically have higher margins than the actual bricks & mortar developers and/or operators. Much like oil services firms, they benefit greatly from the rush of new development, but will also be faced with reduced revenue earlier in the cycle than the actual developers.

One holding I have in this area right now is IBI Income Fund (TSX: IBG.UN). The fund owns 50% of the IBI Group, which provides consulting, planning, design, implementation and analysis for urban land, facilities, transportation and systems projects. They have done everything from designing Alberta’s SuperNet to venue planning for the 2010 Olympics. The other part of IBI Group is owned by a management partnership, whose payouts are tied directly to the payouts IBG makes to unitholders.

Financial Analysis

IBI has been growing steadily over the past few years, through a mixture of organic growth and acquisitions. The company has been buying up small, mature firms with a solid client base around the world as they increase their global presence. While the company still has a heavy reliance on North American revenue, they have been making inroads in China and other emerging markets.

In the most recent quarter, revenues were up 17.4% Y/Y, with organic growth of 13.8%. Their net margin has been increasing as well, although their cash flow decreased slightly due to one-time capital improvements.

For an income fund, distribution cash and payout ratios are of utmost importance. The payout ratio is currently around 80%, which is quite a bit higher than last year. The company has increased distributions twice in the past year, which partially accounts for the higher payout ratio (the capital project costs is also a factor).

Stock Analysis

The company’s float is rather illiquid – the bid/ask spread can be as much as $0.90 at times and the daily volume is quite low. Despite these facts the stock has had a pretty solid appreciation in the past year, mainly due to the increasing distribution.

The company still yields over 8%, which is fairly solid for an income trust with strong growth potential, high cash flows and a good payout ratio. IBI is a relatively small firm (only $144M Cdn market cap), and is only covered by one analyst. This is a company that’s pretty much under the radar, which is part of the reason I like it. In order to reap substantial capital gains on top of the income distribution, its profile will have to be increased. See my comments on investing locally for more details on what I think about under the radar firms.

While the eventual taxation changes to the firm will diminish its income potential in 2011, IBI will still reap a pretty good yield in the future. I think this is a solid medium term holding if you can set a bid at a price you like and be patient for it to be filled.

As I mentioned at the beginning, I think that services firms are a great way to play the infrastructure sector. They typically have better margins and generally do not face cost overrun issues that could materially affect profits. But their performance will lead the sector, since most of their work is done prior to actual development. Thus it’s important to keep an eye on the announcement of future projects and assess when the cycle it nearing its peak.