BAM - Brookfield Delivers Impressive Quarter Shares Remain Deeply Undervalued

2023-08-15 11:24:12 ET

Summary

• Brookfield reported a strong quarter despite less than ideal economic conditions, with distributable earnings increasing, and notable growth in the insurance solutions segment.
• The company's asset management business and insurance solutions business are thriving, presenting significant growth opportunities.
• The asset management business remains the crown jewel for Brookfield, generating $604 million of distributable earnings in the quarter and on track for record inflows in 2023.
• We believe that Brookfield Corporation and Brookfield Reinsurance shares remain deeply undervalued, and that investors continue to assign little to no value to the real estate that the company holds.

We continue to believe that shares of Brookfield Corporation ( BN ) and Brookfield Reinsurance ( BNRE ) remain very undervalued, and we are therefore maintaining a 'Strong Buy' rating. We are providing an update on our March coverage given that Brookfield just reported quarterly results, and that a few things have changed. First, the company has significantly lowered the estimated value of its real estate holdings. This is not surprising given how rising interest rates are pushing real estate cap rates higher, and that office buildings in particular are becoming less attractive as investors realize that the work-from-home trend is likely to persist, reducing leasing demand. The company reduced the estimated value by almost a third, despite many of these assets being very high quality. Second, the asset management business has continued growing at an impressive pace, and has somewhat countered the value lost in the real estate segment. Third, we adjust the value of the company's share in its public subsidiaries using recent prices. The end result is that our estimated NAV per share remains much higher than the current trading price for BN/BNRE, and that current prices still basically give no value to the real estate holdings.

Brookfield Corporation reported a very strong quarter despite less than ideal economic conditions. Even with much lower realized carry, distributable earnings per share for the last twelve months increased by ~7.6%. Distributable earnings before realizations were $1 billion in the quarter and $4.3 billion for the last twelve months, which represents an increase of 21% over the previous year.

Brookfield Reinsurance

Brookfield Reinsurance provides insurance and reinsurance services, including life insurance and annuities, personal and commercial property, and casualty insurance. It is another Brookfield subsidiary, and its shares trade separately from those of Brookfield Corporation. However BNRE shares can be exchanged for BN shares, and they have been paying the same dividend amount. Therefore, while technically they are shares of the reinsurance subsidiary, due to the conversion feature and that they have been paying the same dividend amount, they trade at very similar prices.

It is worth mentioning that the insurance segment continues growing at an impressive pace. The insurance solutions business announced the acquisition of American Equity Life (“AEL”) during the quarter, and delivered distributable operating earnings of $160 million.

Brookfield has been redeploying its short duration investment portfolio into higher yielding assets. During the quarter the average investment portfolio yield increased to 5.4%, and it now has approximately $45 billion in assets. The company believes that this business will achieve annualized earnings of $800 million by the end of 2023. It expects earnings to further increase when it closes its Argo Group acquisition, and once the AEL acquisition is completed. Brookfield previously shared a plan that would take the insurance solutions business to $225 billion in assets, producing distributable earnings of $3 billion by 2027. The acquisition of AEL will grow the business to over $100 billion in assets, making good progress towards its 2027 goal.

Asset Management Business

We continue to believe that the asset management business ( BAM ) remains the crown-jewel for Brookfield. It generated $604 million of distributable earnings in the quarter and $2.7 billion over the last 12 months. Fee-bearing capital increased to $440 billion at the end of the second quarter, resulting in a 16% increase in fee-related earnings year over year. At the end of the quarter, its total accumulated unrealized carried interest was almost $10 billion, a 10% increase over the last 12 months. The business expects to convert over $500 million of carried interest into income during 2023.

Perhaps the most impressive performance indicator is that it is on track to achieve record inflows of close to $150 billion in 2023. This includes capital raised for its latest infrastructure fund, which currently stands at $27 billion.

Operating Businesses

The operating businesses have proven resilient, we recently covered Brookfield Renewable ( BEP ) which continues to grow at a rapid pace and recently agreed to acquire one of the largest renewable platforms in the US, Duke Energy Renewables. Brookfield Infrastructure ( BIP ) is also performing well and recently agreed to take private Triton International for $13 billion, which is the world’s largest inter-modal shipping container owner. These businesses together with the private equity business ( BBU ), and some smaller operations Brookfield owns, generated cash distributions of $397 million in the quarter, and $1.5 billion over the last 12 months.

Valuation

The last time we wrote about Brookfield Corporation / Brookfield Reinsurance we noted that shares were so undervalued that the real estate segment could be had basically for free. The company seems to be aware of the significant undervaluation, mentioning in its most recent shareholder's letter that they see a big gap between intrinsic value and the trading price.

We expect to continue to allocate capital towards share buybacks, given the gap between our intrinsic value and trading price.

In that article we estimated net asset value per share to be ~$54, and ~$33 when ignoring the value of the Brookfield Property Group business. With both BN and BNRE trading around $34, we continue to believe very little value is being assigned to the real estate part of the company. This is despite the company reporting that its core real estate portfolio is 96% leased, and for the most part continues to benefit from strong tenant demand because a large part of these properties are high-quality and have excellent locations. In fact the company is even looking forward to potentially being able to acquire some properties at bargain prices from owners who have capital structures that cannot withstand the current rising interest rate environment.

Below we include an update to the NAV estimates using the most recent share prices for the subsidiaries, and most recent company estimates for the private businesses. The company also changed a little how it breaks down its capital investments. To be very conservative we are ignoring the carried interest. One thing we did notice is that the company lowered significantly the valuation for BPG, from ~$33 billion to ~24 billion. It was partially compensated by a significant increase in the valuation of the asset management business (BAM).

Our updated estimated net asset value per share is ~$47, and ~$32 when ignoring the value of the Brookfield Property Group business. While this is lower compared to the last time we covered the company, it is worth noting that Brookfield made a big adjustment in the valuation of its real estate holdings.

Risks

Brookfield Corporation makes significant use of non-recourse debt, and in some cases could have difficulty refinancing some assets. While small relative to Brookfield's scale, the company has already defaulted on debt related to some lower quality properties. This made news as it fits with the current real estate apocalypse narrative, but the reality is that these were some of the lower quality properties, and a very small percentage of its real estate portfolio. Still, it does highlight the fact that even Brookfield has some properties that have seen their value decline significantly with trends like work-from-home having an important impact.

Most of Brookfield's debt is non-recourse and at the asset/project level, which significantly reduces risks. At the corporate level Brookfield is rated A- or equivalent on its unsecured senior debt by S&P, Fitch, Moody's, and DBRS. The biggest risk we see with Brookfield Corporation is a potential scandal that would tarnish its excellent reputation. As an asset manager, its reputation is critical for investors to trust the company with their capital.

Conclusion

Despite the less than ideal economic conditions, Brookfield Corporation reported another strong quarter. The asset management business and the insurance solutions business are growing at a particularly impressive pace and present the biggest growth opportunities for the company. Other businesses continue performing well, such as Brookfield Renewable and Brookfield Infrastructure. Even the real estate business appears to be in better shape compared to the very negative view that some investors have, with high occupancy and NOI growth. We continue to believe that shares of BN and BNRE are very undervalued, with investors assigning almost no value to the real estate portion of the business. As such, we are maintaining our previous 'Strong Buy' rating for both BN and BNRE.

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