2023-04-14 11:03:02 ET
Summary
- I've become increasingly bullish on big established financial institutions following the collapse of Silicon Valley Bank. This includes big banks and asset managers.
- I discuss in detail why now is a great time to invest into the asset-light and fast growing Brookfield Asset Management.
- It's entirely realistic that today's investors will earn returns in excess of 15% and reach a yield on cost of 7.6% in just a few years.
- This is one of my favorite investments at the moment and a STRONG BUY.
Dear readers/followers,
Most of the analysis I've published on Seeking Alpha so far has been on REITs and as many of you know already, this is no coincidence as I've spent my entire professional career in the PE real estate field. Real estate is my main area of expertise and a sector where I feel I can really bring value to readers.
As an investor, however, I'm not just a REIT guy and in fact only about 20% of my net worth is invested in real estate (both physical and REITs). One other sector that I have become increasingly bullish on is Financials . My thesis since about the middle of last year has been that big banks should outperform in a high interest rate environment. The thesis was based on several assumptions:
- Banks should be able to navigate the environment better than anyone else, because this is their "home course". They understand rates, hedging etc.
- Higher rates enable banks to lend out money at higher rates which in turn results in higher profits. My thinking is that when rates are higher, it is easier to increase the spread between the rate paid on deposits and the rate received on loans.
- Very simply, banks tend to borrow at the short end of the yield curve and lend at the long end of the yield curve so as the yield curve steepens, banks should benefit.
What I didn't see coming (obviously) was the black swan collapse of Silicon Valley Bank and a consequent major selloff in Financials taking the sector from about +6% YTD compared to the S&P 500 to -6% YTD. What's important is that I don't think this bank-run driven event invalidates my thesis. Especially when coupled with the Feds response to provide liquidity to prevent this from happening to other banks. If anything I expect this to be a positive for the big banks as they will be seen as safe heavens and will likely receive additional deposit inflows as people withdraw their money from regional banks. Moreover, as people move their money for "safety" reasons, they are less likely to demand high interest rates on deposits which should improve margins for the big banks. I expect a similar dynamic to play out for other financial institutions such as alternative asset managers as people move their money to the safest firms. This makes today a good time to overweight some of the most established players in the space. That's why today I want to cover Brookfield Asset Management ( BAM ) which is a great example of such institution.
Note: BAM trades in USD on NYSE and in CAD on TSX. This article discussed the USD-denominated security.
Brookfield Asset Management
Brookfield as a whole has a very complex corporate structure, but their asset management business is actually fairly easy to understand and analyze. Last year the parent company Brookfield Corporation ( BN ) spun-off 25% of their asset management business (now called BAM) into a separate publicly traded entity and allowed regular investors to buy shares directly. The remaining 75% ownership interest in BAM remained with Brookfield Corporation.
This is great because it allows investors to invest directly into the easy to understand and asset-light asset manager without the need to understand the complexities of the whole group. It's also great because BAM will likely be one of the fastest growing segments of Brookfield (as they aim to double their distributable earnings in 5 years, implying a 15% per year growth) and should provide solid dividend income as Brookfield plans to be generous with their dividend payout policy at 90%+ (unsurprisingly since they own 75% of the business).
With a dividend of $1.28 per share announced for 2023, the yield stands at 3.8% which isn't high, but if management delivers on their growth target your yield on cost should be double within 5 years. If you're willing to wait a few years, dividend yield on cost of 7.6% on a high quality asset managers such as BAM is nothing to laugh at.
Asset managers run a very simple and safe business model. They get money from outside investors and charge a management fee for investing that money. Their performance then really only comes down to a couple of metrics. The most important one is their AUM (assets under management) and especially their Fee-bearing AUM. Brookfield has a good track record of growing the amount of money they manage as both their AUM and Fee-bearing AUM has increased by 15% YoY in 2022 to $790 Billion and $418 Billion, respectively. This capital is split between five major segments that the Brookfield group operates in (infrastructure, Renewable Energy, Real Estate, Private Equity and Credit and Insurance). Their ability to continue to grow their Fee-bearing AUM will be crucial to the performance of our investment.
Beyond AUM we only need to focus on three numbers - fee revenues, fee-related earnings and distributable earnings. In 2022, fee revenues have grown by 20% YoY to just over $4 Billion representing an average fee of roughly 1% (that's roughly in line with the industry average). Segment wise the revenue was mostly generated in proportion to assets in each of the five segments. Credit and infrastructure accounted 25% of revenues each, followed by Real Estate (23%), Renewable Energy (16%) and Private Equity (11%).
Their margin improved throughout 2022 to 58% which led to a phenomenal 26% YoY increase in Fee-related Earnings (FRE) to $2.1 Billion or $1.29 per share. Negligible equity-based compensation and taxes meant that distributable earnings came in just one cent lower at $1.28 per share.
Future earnings visibility is supported by the fact that 83% of Fee-bearing Capital is invested in long-dated or perpetual strategies which leaves only 17% for liquid strategies where it is easy and fast to pull out the investment. Moreover BAM has significant liquidity on hand for future investment opportunities with $3 Billion in cash, $87 Billion in uncalled commitments which don't expire until after 2027 and no debt . While this alone won't be enough to achieve their target of doubling their distributable earnings in 5 years, it takes them about 25% of the way there already.
Hopefully by now, I've made you interested in the company so let's have a look at valuation. BAM currently has a market cap of $55 Billion. That means that it's trading at 13% of Fee-bearing AUM. In other words for every dollar you invest into BAM, you get $7.60 in Fee-bearing capital. For comparison, with Blackstone ( BX ) you get only $7. Which makes BAM look cheap, especially when you consider that they have been growing their AUM faster than Blackstone and in my opinion have a better (faster growth) investment split focused more on renewable energy and infrastructure as opposed to more traditional alternative asset classes such as real estate favored by Blackstone.
Another way to look at the valuation is to look at a multiple to Fee-related Earnings. BAM trades at a premium here - 26.2x FRE compared 23.8x for BX. Thanks to their faster growth I'm fine with some premium, but would lower my target multiple to 25x just to be conservative. I'm also going to assume that they fail to achieve their growth target and instead of growing by 15% per year, they're only going to grow by 10% per year. In three years, there Fee-related Earnings should grow to $1.7 per share giving me a price target of $42.50 per share. That's a 27% upside in addition to the dividend.
So using this decreased level of growth and a conservative multiple I expect:
- dividend yield of 3.8% in 2023 (growing at 10% per year)
- distributable earnings growth of 10%
- no upside from multiple expansion
- total expected return of 12%
And that's using assumptions that frankly given their track-record and the amount of uncalled capital at their disposal could be considered as worst case scenario. It would not be unrealistic for them to achieve the 15% growth target which would result in greater upside and a yield on cost of 7.6% within 5 years. Those are really solid results! Combined with the fact that the sector as a whole has been unfairly punished by the collapse of Silicon Valley Bank creating an opportunity to enter at a good level, I rate BAM as a "STRONG BUY" here at $33.50 per share with a price target of at least $42.50 per share, but will likely hold this one for the long-term.
What are the risks?
Of course it's impossible to know whether management will succeed in growing their AUM. Since the stock price and dividend growth will more or less mirror AUM growth, if AUM stagnates, so will our investment. Moreover, if the economic situation worsens significantly, investors could try to pull out their money which would hurt BAM even more. I don't see this happening though and even if it does, thanks to a high percentage of capital tied up in long-term strategies, AUM won't drop overnight. As such the risk of a "bank run" is minimal for BAM.
For further details see:
Brookfield Asset Management: Well Positioned To Outperform