BAM - Brookfield Asset Management: Great Business But Not The Right Time

2023-11-03 00:46:32 ET

Summary

• Brookfield Asset Management is still growing with a solid pace, has still high inflows, and management is very optimistic for the next few years.
• But I see the current environment as challenging for asset managers, and there is the risk for lower income in the coming quarters.
• The company has to grow in the mid single digits to be fairly valued, and while this seems achievable over the long term, we have to be cautious near term.

In my last article about Brookfield Asset Management ( BAM ), I wrote that caution is advised. And since the article was published in June 2023, the stock lost more than 10% in value. However, my fear for most banks and asset management companies is not a loss of 10%, 15% or 20% but stocks crashing hard in the coming months and quarters. And we also must keep in mind that several major banks in the United States and Canada already declined between 20% - JPMorgan Chase ( JPM ) - and as much as 50% - U.S. Bancorp ( USB ).

Nevertheless, Brookfield Asset Management is an interesting story and interesting pick as it seems like the textbook stock and company to demonstrate and discuss the complexity in investing and show how difficult it is to come up with good investment decisions. This article will therefore be structured like a disputation between bulls and bears. On the one hand we have a great business, but on the other hand we have a very risky market environment. Let's start with the positive side.

Great And Undervalued Investment

When looking at the reports and presentation there only seems to be one conclusion possible: Brookfield Asset Management is a great business, growing with a high pace and high level of consistency. And when calculating an intrinsic value by using different valuation metrics, the stock also seems to be undervalued.

Still Growing

And when looking at the results in the first six months of fiscal 2023, Brookfield Asset Management generated $2,039 million in total revenue. Compared to $1,679 million in the same timeframe last year, the company increased its revenue by 21.4% - an impressing growth rate in the current environment. Net income however declined 4.5% year-over-year from $1,016 million in H1/22 to only $971 million in H1/23.

And when looking at the last twelve months, the company is still performing great considering that fee revenues were $3,712 million in the last twelve months leading up to Q2/22 compared to $,4256 million in the last twelve months. This is resulting in 14.7% year-over-year growth. And distributable earnings per share increased from $1.22 in the twelve months leading up to Q2/22 to $1.33 in the last twelve months - 9.0% year-over-year growth.

Still Raising Capital

Brookfield Asset Management is also able to grow its assets under management and the fee-bearing capital - the metric driving revenue and income for Brookfield Asset Management. In the last twelve months, fee-bearing capital increased from $392 billion in Q2/22 to $440 billion - resulting in 12% year-over-year growth which was especially driven by $74 billion in fundraising. In total, Brookfield Asset Management had $85 billion in inflows (also including prior uncalled commitments that was not previously included in fee-bearing capital).

When looking at the last few quarters, we see that inflows were declining and inflows in Q1/23 or Q2/23 were not nearly as high as the inflows in 2022. Nevertheless, Brookfield Asset Management is still raising cash - for example, $12 billion for a global private equity fund recently.

At the end of the second quarter, Brookfield Asset Management also had $83 billion in "dry powder" - uncalled fund commitments that are ready to deploy into attractive, risk-adjusted opportunities once Brookfield Asset Management has identified these opportunities.

Still Optimistic

And management is still extremely optimistic for the next few years. During the company's 2023 Investor Day management also reaffirmed the very optimistic targets for the next few years.

Management also pointed out it was beating its previous targets. While management told investors in 2018 that the company will double its fee-bearing capital over the next five years - till 2023 - it actually more than tripled it and fee-bearing capital was growing with a CAGR of 27% between 2018 and 2023. Brookfield Asset Management achieved growth by three different strategies in the last few years: the acquisition of Oaktree, by larger flagship funds and by new business lines and strategies. And the company being able to beat its already optimistic targets in the past should make us optimistic Brookfield Asset Management will be able to do so in the future as well.

Over the next five years - till 2028 - Brookfield Asset Management is expecting its fee-bearing capital to grow with a CAGR of 18% and exceed $1 trillion by 2028.

Risky And Challenging Environment

And while Brookfield Asset Management is still performing great, management is still optimistic for the years to come and business is continuing to raise capital, I would be rather cautious for the next few years. While Brookfield Asset Management is reporting still great numbers, other data should make us a little more sceptic.

In my last article about Allianz ( OTCPK:ALIZF ) - a German insurance company and asset manager - I pointed out that regional banks as well as asset managers have been underperforming lately and that investors are obviously rather cautious about these types of investments.

And Brookfield Asset Management also declined rather steep from its recently set all-time high and lost about 20% in value in the last few weeks.

Of course, the stock performance is not telling us much about the fundamental performance of a business - it is telling us much more about the sentiment of investors and if they are rather greedy or rather fearful. However, when it comes to investing, banks or asset managers aspects such as trust, confidence, or fear play an important role.

But not only is the stock performance indicating trouble down the road - other metrics are also pointing towards distress in the economy. In my recently published article Now, Where Is Your Recession ? I wrote about the rising delinquencies and about the rising number of bankruptcies. I also wrote about the possibility of the stock market declining steeply. And although Brookfield Asset Management is not investing in stocks and is therefore not directly affected by declining stock prices, a market environment with declining asset prices and maybe fear and panic ruling the street will have an impact on alternative asset managers as well.

And rising delinquencies and bankruptcies will also have an impact. When talking about these risks, we can start by mentioning once again that Brookfield Asset Management is an asset-light business, meaning it doesn't own the assets itself - compared to most banks or other asset managers that actually have the assets on their books. I already wrote about this in my last article:

Brookfield Asset Management is also structured in an "asset-light" way as it does not have many assets on its balance sheet (and therefore limited the risk of declining assets). It makes its money via fees it receives for its management of funds from outside investors and when these funds decline in value it's the investors' problem.

And even if Brookfield Asset Management is not directly losing money (as we are dealing with an asset-light business), investors might lose money, and this is once again impacting investor sentiment. Overall, this will lead to lower inflows (or even to outflows) of cash.

Brookfield Asset Management is generating its revenue and income mostly by investing in five different asset classes. And for starters, renewable energy and power as well as infrastructure can be seen as rather safe investments. These two asset types can be seen as rather recession-resilient, and both are necessary, everyday aspects of our lives - we need infrastructure, and we need energy. However, assets belonging to the categories "Real Estate" as well as "Credit & Other" are usually affected by the state of the economy and a recession. When looking at fee-bearing capital, $152 billion for Credit & Other as well as $98 billion for "Real Estate" are a huge part of the portfolio and about half of management fees also stems from these two - $992 million was generated from Real Estate in the last four quarters and $1,022 million from Credit and Other.

Overall, we can show that asset managers (especially the stocks) are not performing well in times of economic distress. When looking at the major asset managers in the world, we see these stocks declining steep in recessions - especially during the Great Financial Crisis. Asset managers are belonging to those categories of stocks that are seen as rather risky and in case of a recession and bear market they sell off rather steep (if that is justified or not is another question).

Valuation

And there is another difference between many banks mentioned above as well as asset managers like Allianz on the one side and Brookfield Asset Management on the other side. While most banks don't have to grow earnings at all to be fairly valued, Brookfield Asset Management has to grow in order to be fairly valued. And while most banks are trading for single digits or very low double digit valuation multiples, Brookfield Asset Management is trading for about 22 times earnings and the stock is therefore valued more expensive.

When looking at the expectations of management and high double-digit growth rates, Brookfield Asset Management is undervalued. But what if these growth rates will not happen in the next few years. What if Brookfield Asset Management cannot grow in the next few years - then the stock would be overvalued.

When using a discount cash flow calculation and taking 1,635 million outstanding shares, a 10% discount rate and $2,183 million in distributable earnings as basis, Brookfield Asset Management has to grow between 5% and 6% from now till perpetuity in order to be fairly valued. And I assume that the stock might drop if the company is suddenly reporting much lower growth rates. Of course, over the long run I am very confident that the business is able to grow at least in the mid-single digits.

Bottom Line

Overall, I would see Brookfield Asset Management somewhere between a very cautious "Buy" and still a "Hold". I don't think one will regret buying Brookfield Asset Management today when looking back in 10 or 15 years from now. But every buyer should have a strong stomach in the coming years and really be prepared for much lower stock prices in the coming quarters or years.

Brookfield Asset Management will report earnings next Monday and I don't necessarily think the company will already disappoint this time - as most other financial institutions still reported solid results. But I am actually expecting earnings to be much lower than estimated in the coming quarters. And I neither know how the stock will perform in case of a huge earnings miss, nor do I know how Brookfield Asset Management will perform in case of a huge stock market sell-off. But I see the risk of Brookfield Asset Management declining rather steep in the coming months - although the stock certainly cannot be called overvalued at this point.

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