BIP - Brookfield: Misunderstood And Extremely Attractive

Summary

• Brookfield Corporation is the head of the difficult-to-understand empire.
• BN benefits from growth across all Brookfield entities and thus offers broad-based real asset investment exposure.
• BN is inexpensive and has considerable upside potential.

Article Thesis

Brookfield Corporation ( BN ), the newly created "mothership" of the Brookfield investment universe, is underfollowed and misunderstood by some investors. At current prices, it offers compelling returns over the coming years, I believe, thanks to an inexpensive valuation and considerable growth tailwinds.

A Very Complicated Network Of Companies

There used to be several Brookfield entities investors could pick from when making "real asset" investments. This includes the infrastructure business ( BIP )( BIPC ), the Renewable Energy business ( BEP )( BEPC ), the private equity business ( BBU ), the reinsurance business ( BNRE ), and the previous head of the empire, the "old" Brookfield Asset Management, which had the ticker 'BAM'.

In a recent move, that old BAM was split up, however, as Brookfield decided it wanted to create an asset-light asset manager investors could invest in directly, without owning a stake in the "mothership". This new asset-light asset manager has taken over the ticker 'BAM', while Brookfield Corporation, the "mothership" that owns stakes in all the daughter entities, has started to trade under the ticker 'BN' in late 2022.

Investors that want to own a stake in the head of the alternative asset management empire thus need to invest in 'BN', whereas 'BAM' is not the same company it used to be in the past -- it's not one of the daughter entities in the Brookfield empire, albeit an attractively priced one.

All these name changes and complicated constructs, where one Brookfield entity owns stakes in other Brookfield entities, make the asset management empire hard to understand. This is why many investors don't want to invest in any Brookfield companies, as they feel overwhelmed by how complicated things are -- contrast this with a company like Apple ( AAPL ), where it is pretty clear what you get and where there is no reason to decide between different Apple entities. That is unfortunate, however, as the Brookfield empire provides a range of attractive investment opportunities, one of them being Brookfield Corporation itself, the head of the empire.

Brookfield Corporation Benefits From Growth Across The Whole Empire

The daughter entities are specialized, thus they only benefit from direct growth in their area of expertise. Brookfield Corporation, on the other hand, is an allrounder that is exposed to all the growth vectors across the empire -- it benefits from growing renewable investments via its stake in BEP, it benefits from the data center and pipeline businesses via its stake in BIP, it benefits from the growing asset management business via its stake in BAM, and so on. In short, every time there is any growth in any corner of the empire, BN, the head of the empire, benefits. An investment in BN thus offers broad-based exposure to the real asset investment world, in a way that is not possible via the more specialized daughter entities.

For its publicly-traded daughter entities Brookfield Renewable Partners and Brookfield Infrastructure Partners, Brookfield has forecasted annual funds from operations growth in the high single digits. On top of that, they both offer mid-single digits dividend yields. It would thus not be surprising to see BN's stake in these companies deliver a low-teens annual return, which would be quite attractive. BN's stake in BAM, the recently-created asset-light asset management business, will likely deliver a higher return. With a dividend yield in the 4%-5% range and growth likely in the double-digits thanks to ongoing strong assets under management growth, BAM could deliver total returns in the 15%-20% range for BN (and outside investors), I believe.

BN Is Inexpensive

BN's exposure to BAM is larger compared to the other two Brookfield entities, as BN owns around $38 billion worth of BAM today, while its stakes in BEP and BIP are currently valued at around $9 billion and $7 billion, respectively. The more pronounced exposure to BAM, where I expect higher returns versus BEP and BIP, should juice BN's returns, all else equal. Between these three investments, BN thus owns around $54 billion worth of assets already. Of course, there are additional assets to consider. Brookfield's private equity business, BBU, does not receive a lot of attention, mainly due to the fact that its very low yield makes it uninteresting for income investors while the volatility of results makes BBU more complicated to value and understand. BN's exposure isn't very large, but at around $3 billion, it's not negligible, either.

The value of BN's owned real estate portfolio is much more significant, especially since BN took its publicly-traded real estate daughter (Brookfield Property Partners or BPY) private a couple of years ago. These properties include office buildings and malls, two real estate categories that have not performed too well in recent years due to the pandemic, work-from-home trends, and so on. That being said, Brookfield's properties are generally high-quality ones (e.g. One Manhattan West in New York, Fashion Show in Las Vegas), where there is little risk that they will go unused, although rising interest rates result in rising cap rates, which depresses the value of these properties to some degree. That being said, the portfolio should still be worth many billions of dollars.

In the 2021 Annual Report (the 2022 report isn't out yet), Brookfield stated that the common equity position of Brookfield Property Group, its fully-owned real estate business, was $32 billion. One can argue that this is too high, as the business generated just $750 million of funds from operations. We can go with the 2020 equity value to be conservative, which would mean slightly less than $20 billion in current value for Brookfield Corporation.

There are also Brookfield's insurance business, assets on its balance sheet, and the carry it owns in the funds that are managed by the new BAM. All in all, this pencils out to a figure of around $100 billion. Of course, that has to be adjusted for BN's debt and preferreds, but even then, we get to around $85 billion or so. Accounting for BN's fully diluted share count of 1.61 billion (according to YCharts), we get to a per-share value of $53. Not all of these assets can be valued precisely, of course, and one can argue what cap rate to use for the real estate business, for example. But it is pretty clear that the per-share value of the assets that BN owns is significantly higher than the current share price of $35.

BN is complicated, it is not a very straightforward business to invest in, and there is a small dividend yield only. A case can thus be made that it should trade at a discount compared to the value of all its holdings. But even if we round down the $53 estimate to $50 and apply another 20% discount, BN would still be undervalued today, as it trades at $35 versus a $40 "double-discounted" fair value. I thus am convinced that BN is currently a good value. That does not mean that shares will climb immediately or even in the foreseeable future, as it may take a while for the market to realize the value of BN. But for long-term-oriented investors, that should not be too much of a problem. The underlying value of the assets BN owns should climb in the long run, due to cash inflows from the daughter entities (dividends) and the real estate portfolio, while the value of these assets should climb over time as well.

When the market eventually comes to the conclusion that BN should trade at a higher valuation relative to the assets it owns, and when those investments have become more valuable over time, BN could see considerable share price gains. Let's assume that BN compounds the value of its assets by 10% over the next five years (starting with the $53 estimate from above), and that BN is valued at 0.8x this value five years from now. That would result in a share price of $68 five years from now, which would allow for share price gains of 14% per year. Add the small dividend, and 15% annual total returns seem possible (although they are not guaranteed, of course).

Takeaway

BN is underfollowed, hard to understand (and value), and thus many investors avoid it. But I believe that there is a good chance that the head of the Brookfield empire will be a compelling long-term investment. Shares trade at a hefty discount compared to the net asset value of what the company owns, I believe.

Brookfield Corporation should benefit from the growth its daughter entities generate, and thus offers potential for investors to benefit from the broad real asset investment theme. While the dividend yield is low, total returns could still total 10% and more per year over a multi-year time frame, thanks to a combination of valuation expansion and underlying business/asset value growth.

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