2023-11-09 09:00:52 ET
Summary
- Brookfield Corporation's third-quarter earnings beat analyst expectations, showing high revenue growth with earnings holding steady.
- Rising interest rates have impacted the company's earnings, but the threat is cooling off.
- Brookfield continues attracting investors to its infrastructure funds despite the serious allegations that have been made against Brookfield Infrastructure Partners.
- In this article, I make the case that Brookfield stock is a decent buy after its third-quarter earnings release.
Brookfield Corporation (BN) just released its third-quarter earnings , easily beating analyst expectations. The release showed high growth in revenue. Distributable earnings per share were unchanged compared to the second quarter. For those not familiar with Brookfield, "distributable earnings," or DE, is the company's measure of what can be distributed to shareholders. It serves the same purpose as adjusted earnings at other companies and is treated much the same way by BN shareholders. This time around, the estimate was for $0.67 in DE per share, which was beaten by the $0.73 that was actually delivered. So, a pretty good showing by Brookfield all around.
This year, interest rates have been a major concern for Brookfield. In the second quarter, the company's earnings declined 91% , thanks largely to a $1.4 billion increase in interest expenses. Higher interest rates on variable rate debt were responsible for $879 million of that $1.4 billion increase.
In the third quarter, treasury yields began moving in a big way. The 10 year treasury (US10Y) at one point was approaching 5.5%, the highest yield it had seen in over a decade. Since then, things have cooled off, but the damage to BN shares was done. They are still down significantly from where they were before treasury yields started climbing.
As Brookfield showed in its third-quarter earnings release, the interest rate threat is cooling off. Interest expense once again increased dramatically on a year-over-year basis, but it actually decreased slightly from Q2. All-in-all, BN's management is handling the increase in interest rates well. The company should be safe if rates stay where they are now, and may even see an increase in earnings if the Fed starts cutting rates.
When I last covered Brookfield, I rated the stock "buy" on the basis of the fact that it was fairly cheap and performing well. Since then, the stock has fallen in price and put out a commendable earnings release. Accordingly, I now consider the stock a strong buy, as I will explain in the ensuing paragraphs.
Earnings Recap
Brookfield Corp put out a strong earnings release for the third quarter . In the quarter, the company delivered:
-
$24.4 billion in revenue, up 4.5%
-
$35 million in GAAP net income, down 95%
-
$1.15 billion in distributable earnings, down 15%
-
$0.73 in earnings per share ("EPS"), down 14.1%.
These results are better than they look. Although they are down on a year-over-year basis, some of them (e.g., distributable earnings) are up compared to Q2. The growth from Q2 earnings levels was respectable. Analysts expected lukewarm results from Brookfield, and the company gave them more than what they expected.
Particularly encouraging was the company's cost breakdown. In the quarter, operating costs came in at $5.5 billion, which included $3.75 billion in interest expense. The rate of growth in interest expenses slowed significantly, which helped Brookfield crank out distributable earnings that it can now pass on to its shareholders. In the past, Bruce Flatt hinted that he was open to ramping up BN's buyback program, which would be a boon to shareholders if Flatt went ahead and did it.
Will he go ahead and do it? That remains to be seen. In the third quarter, Brookfield bought back $400 million worth of stock, which is a significant amount, but not enough to really move the needle. If BN were to start buying back $1 billion worth of stock per quarter-and there's enough distributable earnings to do so-it would make a very big difference, and possibly be a bullish catalyst for Brookfield.
Brookfield Infrastructure Partners: Accusations Fly!
One piece of the Brookfield Empire that we got updates on in the third quarter earnings release was Brookfield Infrastructure Partners ( BIP ). This partnership was a target of a scathing short report by Keith Dalrymple, who called the stock a clear sell. The report was so influential that one writer sold his entire position based on it alone!
Brookfield's third-quarter release showed that BIP is not preventing the company from ramping up its infrastructure investments. In the Q3 release, Brookfield said that it had finished raising capital for the largest infrastructure fund in the company's history. Whether the accusations against BIP are true or not, the company's infrastructure business is certainly generating management fees for Brookfield Asset Management.
Latest Deals
One promising thing for Brookfield's future is its continued deal-making. The company made some noteworthy investments in the last five years, including Westinghouse and a 67% stake in Oaktree Capital. By all accounts, it intends to keep that tradition going. This year, the company acquired insurer American Enterprise and the transportation company Triton. American Enterprise now contributes to the earnings of Brookfield's insurance subsidiary. That's important because insurance is one of Brookfield's most promising new lines of business. In the third quarter, it did $182 million in earnings, growing at 14% year-over-year. If Brookfield can keep making profitable acquisitions like AEI, then it will be able to grow its business and pass its wealth to shareholders.
The main impediment to that happening would be high interest rates. As we saw in the third quarter, the current, relatively high interest rates have not prevented Brookfield from becoming profitable. However, they are leading to increasing interest expenses. Currently, Brookfield's weighted average cost of debt is about 4.5%. It aims to buy companies that generate 7% returns on capital or better. Provided that interest rates stay where they are now, such returns will be adequate to give Brookfield good results. The company is very highly leveraged, with a debt-to-common equity ratio of five (calculated by the author using BN's balance sheet ). This amount of leverage presents certain risks but it also amplifies returns provided that management can find deals that promise returns greater than the company's own cost of capital. As we saw in the third quarter, Brookfield is producing a lot of earnings to distribute to investors, though interest expenses are clearly weighing on bottom-line results.
Profitability
Brookfield's Q3 release gave us a fresh look at the company's profitability. The release showed $1.15 billion in distributable earnings and $24.4 billion in revenue. Substituting DE for net income, gives us a 4.5% net margin, which is pretty good for a highly leveraged firm like BN. Using trailing 12-month data, Seeking Alpha Quant puts BN's EBIT margin at 17.4% and its free cash flow margin at (14.7%). Its return on capital is 3%. All in all, pretty good profitability metrics for a company managing piles of debt in a period of rising rates.
Growth
Growth is one area in which Brookfield has excelled this year. Although the most recent quarter's growth was negative, the year-to-date metrics are pretty encouraging. In 2023 so far, Brookfield has done $4.05 in distributable earnings before realizations, which if you adjust for the special distribution, is up 4.7%. On a five-year CAGR basis, Brookfield has grown at the following rates:
-
Revenue: 12.3%.
-
EBIT: 14%.
-
EBITDA: 17.4%.
-
Free cash flow: 13%.
-
GAAP net income: -40%.
Apart from GAAP net income, these are all very good growth rates. Remember that Brookfield spun off 25% of Brookfield Asset Management ( BAM ) last year, which resulted in a small chunk of revenue and earnings disappearing. That's a downer, but Brookfield shareholders who were holding at the time were compensated for this small loss by being given BAM shares.
Valuation
Having looked at Brookfield's most recent quarter, we can now attempt to value the stock. Here, the metric we want to look at is distributable earnings, which is a cash flow metric very similar to free cash flow. The DE figures for the last three quarters were as follows:
-
Q3: $0.73.
-
Q2: $0.75.
-
Q1: $0.72.
-
Q4 2022: $0.71.
These amounts sum to $2.91. Using that figure, we get a P/E ratio of 11 and a discounted cash flow ("DCF") fair value estimate of $38 using the current treasury yield plus a 3% risk premium as the discount rate. These metrics suggest that Brookfield stock is currently pretty cheap, but not outrageously undervalued.
The Bottom Line
The bottom line on Brookfield's third-quarter earnings release is that it delivered about what investors expected: modest growth compared to the second quarter. The company was not able to grow on a year-over-year basis because interest rates rose dramatically in the last 12 months, but its revenue and DE before realizations improved compared to Q2. This shows that most of the damage Brookfield has taken from rising interest rates is already done. So, the company has a good shot at delivering value to shareholders, provided that the Fed is done hiking rates.
For further details see:
Brookfield Beats Q3 Earnings: Back Up The Truck