InfraREIT - Financial Engineering Continues in the Utility Sector

InfraREIT (HIFR) is the first publicly traded high-voltage electric transmission company wrapped in a REIT structure.  Spun off from the Hunt family of companies in January, HIFR is structured more like a MLP than a traditional REIT. 

InfraREIT is a real estate investment trust REIT. The Company owns state-regulated electric transmission and distribution (T&D) assets, such as power lines, substations, transmission towers, distribution poles, transformers and related property and assets, in Texas. The Company leases its T&D assets to Sharyland Utilities, a Texas-based regulated electric utility privately owned by the Hunt family. The Company owns T&D assets throughout Texas, including the Texas Panhandle near Amarillo, natural gas rich Permian Basin, Central Texas, Northeast Texas, and South Texas.  Its T&D assets consist of approximately 50,000-electricity customer delivery points, approximately 620 miles of transmission lines, approximately 10,500 miles of distribution lines, 35 substations and a 300-megawatt (MW) high-voltage direct current interconnection (DC Tie) between Texas and Mexico.  75% of total assets are high-voltage transmission lines.  

Taking a page out of the MLP playbook, HIFR owns the assets, but there is no management team to run the operations.  Similar to a General Partner, IHFR has hired a Hunt-affiliated management company, appropriately called Hunt Management,  for operations and will pay a two tiered management fee.  The first is similar to the IDRs, or Incentive Distribution Rights, usually associated with General Partners and includes a fee of 20% of the shareholder distributions over $1.07 a year.  The second is a fee equals to 1.5% of shareholder equity with a minimum of $13 million and a maximum of $30 million (or $0.22 to $0.50 a share, based on 60 million shares outstanding). 

HIFR will purchase all projects developed by Hunt Development, a construction arm of the Hunt family, which falls within its service territory.  In addition, HIFR has the right of first option to buy several other transmission projects in the planning stages through Texas. 

HIFR currently has a rate base of $1.1 billion and plans on expansion of around $775 million over the next few years.  The current configurations of its assets lie within the boundaries of Texas and falls under the jurisdiction of Texas state utility regulators. Regulators have approved a 9.7% return on equity, Based on 55% debt and 45% equity structure.   As HIFR gains in size, it should be expected management will look to expand into interstate transmission assets as these are regulated by the federal government and offer a higher ROE of upwards of 11.5%.   

Management expects to grow its business by 10% to 15% a year, in line with other transmission firms like ITC Holdings (ITC).  The initial annual dividend is set at $0.90 and dividend growth should match the expansion of the firm’s underlying profits, as a REIT needs to distribute 90% of its taxable income.   

The book-runners of the IPO have issued their analysis of HIFR.  While it may be a bit self-serving to be the underwriter of the IPO and have a “Buy” on the stock, Citigroup initiated coverage at “Buy” with a $33 price target.   RBC Capital and Wells Fargo initiated coverage at Outperform.  At its current price of $27, HIFR is anticipated to generate a 13% to 15% annual total return, including a 3.3% current yield. 

Based on a 45% equity contribution and an aggressive capital expenditure growth program, current shareholders should expect share dilution over the next few years.  As there is very little in retained earnings within the REIT structure, future rate base asset acquisitions will be financed by the PUCT–approved formula of 55% debt and 45% equity.  The Hunts could increase their share count as partial payment for future dropdowns.     

As the overall utility sector continues down its path of financial engineering and consolidation, transmission REITs may be the next wave for regulated electric utilities.  Most all electric utility investors should be cognizant of the happenings over at InfraREIT.      

While IPOs are not usually part of our stock universe, HIFR is a bit different.  Founded in 1990s and converted to a REIT in 2010, the Hunt family still owns 27% of HIFR.  The company has a sizeable asset base, its profits are regulated,  and the ability to participate in drop-down assets from the Hunts.      

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This article first appeared in the April 2015 issue of Guiding Mast Investments newsletter.  Thanks for reading,  George Fisher