2023-05-12 11:44:36 ET
Summary
- The Brookfield empire is hard to understand.
- BN is the head of the empire, but does not receive a lot of attention.
- BN has a good growth outlook and trades very inexpensively.
Article Thesis
The Brookfield empire is complicated, and the head of the empire, Brookfield Corporation ( BN ), does not receive a lot of attention. The company has generated excellent results during the first quarter, however, and the valuation is low, which I believe makes for an attractive investment.
A Complicated Company
Brookfield is an alternative asset manager that is focused on real assets such as real estate, infrastructure (pipelines, electricity transmission, and so on), and similar "hard assets". This provides above-average inflation protection. Brookfield believes that there is a lot of market growth potential over the coming years and decades, as institutional investors such as insurers have low allocations to this space for now, but will likely increase their allocation to hard assets in the future -- due to attractive returns and built-in inflation protection.
Brookfield has a wide range of entities on the market, which includes publicly-traded offspring Brookfield Renewable Partners ( BEP )( BEPC ), Brookfield Infrastructure Partners ( BIP )( BIPC ), Brookfield Asset Management ( BAM ), and Brookfield Business Partners ( BBU ). Some of these, BEP and BIP, have a dual listing as they trade both as an LP and as a corporation. Overall, this makes for a highly complicated and hard-to-understand range of different Brookfield entities. Some investors don't want to spend the time to understand all of these units and how they are related to each other, which unit is managed by which, and so on. This likely explains why the Brookfield empire is getting less attention than it deserves, as the operational performance has been highly compelling, and since the growth outlook is excellent as well. The below-average attention it receives, due to being so complicated, likely explains why valuations are rather low.
The head of the empire, Brookfield Corporation, or BN, was called BAM in the past, while BAM is now the ticker symbol for a different Brookfield entity -- this hasn't made things easier to understand, for sure. BN (the parent company) is a highly attractive investment, as it benefits from the growth of its publicly traded offspring entities while also owning a large number of additional assets. Add a low valuation, and BN looks highly compelling.
Brookfield Corporation's Strong Results
Over the last weeks, the different Brookfield entities have reported their respective earnings results for the first quarter. This also includes the earnings report from Brookfield Corporation, the "mothership". BN reported its results on May 11, but there was little coverage in financial media, Seeking Alpha being an outlier -- its coverage is available here . Let's take a closer look.
The headline numbers can be seen in the screen capture above, and as we see, there was a nice double beat. Both revenues and profits came in well ahead of expectations, which naturally is a great feat.
Brookfield's earnings are somewhat difficult to analyze, due to there being many moving factors. The same holds true for other alternative asset managers such as Blackstone ( BX ), where profits can also be lumpy. In BN's case, realizations play a major role in profits, but they are uneven on a quarter-to-quarter basis and also dependent on the overall market environment. They can mask underlying business growth, which is why I believe that it is better to focus on Brookfield's earnings before the impact of realizations, as that better reflects the underlying growth via higher fees etc.
In the most recent quarter, there was an additional factor to consider. BN split off a portion of its asset management business, which is now listed under the ticker BAM. This has lowered the profit that is attributable to BN's shareholders, but that was a one-time item -- once the spin-off is lapped, this headwind to BN's reported growth will be gone. The "distributable earnings before realizations, adjusted for the special distribution [BAM shares]" line thus best reflects the underlying business growth that BN's shareholders will benefit from in the future. These results were up 15% year over year, which is highly compelling, especially when we consider BN's pretty low valuation -- more on that later.
On a per-share basis, these underlying profits grew nicely as well, from $0.51 to $0.59, which represents growth of 16%. Brookfield is buying back its own shares on the market, which helps boost its earnings per share growth rate versus the company-wide net income growth rate. The difference isn't drastic, of course, but over time, buybacks could accelerate, and the per-share growth rate could receive a more meaningful boost. The company has already accelerated its buyback pace, spending $300 million on share repurchases over the last quarter, or around twice the pace seen over the previous three quarters. If BN continues to spend $300 million per quarter on buybacks, that would make for an annual share count reduction of around 2.5%.
When we include realizations, profits were down marginally compared to one year earlier, but when market conditions improve, Brookfield's realizations should increase again, and per-share profits should do so as well.
The company's performance over the last four quarters was compelling as well, as the adjusted profit growth rate was 24%, while earnings per share are up versus the previous year, despite the headwind from the special distribution of BAM shares.
This growth is largely driven by higher distributions from Brookfield's asset management business. Due to the aforementioned fact that institutional investors are under-allocated to hard assets that provide above-average inflation protection, they want to up their exposure. The Brookfield empire has thus been raising funds at a hefty pace in recent years, and I don't believe this will change any time soon. When more capital is being deployed, Brookfield receives higher fees due to managing more assets. At the same time, variable costs aren't overly high when managing additional money, thus this growth in fees is highly accretive to Brookfield's profits.
Brookfield's insurance business also was a major growth driver for profits in the recent past. This relatively new business has seen explosive profit growth over the last year, as distributable earnings rose more than 10-fold from $13 million to $145 million. This was partially driven by M&A, and Brookfield plans to grow the business inorganically in the future, too. This includes the recently-announced acquisition of specialty insurer Argo Group, which will likely close during the second quarter. While growth will not be maintained at the extraordinary relative growth rate seen during the first quarter, it seems likely that Brookfield's insurance business will continue to be a profit driver in the long run, as Brookfield grows this franchise organically while additionally juicing the growth rate via tuck-in acquisitions.
Brookfield's operating businesses, i.e. BEP, BIP, BBU, and the real estate business that is fully owned by BN, have, in total, generated lower profits during Q1, relative to the previous year's quarter. That was solely driven by weaker profits in the real estate franchise, however, as BEP, BIP, and BBU (the publicly-traded operating businesses) all contributed higher profits.
The real estate business faces headwinds from higher interest rates, which is why the quarterly profit contribution sank to $150 million -- that being said, that's still a nice $600 million annual profit. Even with an earnings multiple of just 10, the real estate business would thus mean a $6 billion equity value for BN. Since many of the properties that BN owns are high-quality trophy assets in major cities, one could also ascribe higher earnings multiple -- make it 15, and the real estate business has an equity value of $9 billion.
Recently, there has been some news about problems in the commercial real estate space, but due to the high average quality of BN's properties, it should, I believe, be less affected. On top of that, the company makes sure that debt is held at the property level (non-recourse) and that failures in single properties do not impact the company as a whole. This is a very prudent move to lower risks as much as possible.
Brookfield Corporation trades at $31 at the time of writing, which is equal to around 9.5x the distributable earnings seen over the last twelve months. That could be appropriate for a company with no growth at all, but BN could show very meaningful earnings and net asset value growth in the coming years and in the long run. Fellow Seeking Alpha contributor Stephen Frampton has recently calculated that BN would be fairly valued right now if both the insurance business and the real estate business had a value of zero. One can argue about the exact value of these, but it's pretty clear that they have significant positive value, with combined profits of around $300 million per quarter or $1.2 billion per year. This supports my belief that BN is undervalued today, as both a sum of the parts calculation as well as an earnings multiple view get to the same conclusion.
Takeaway
The Brookfield empire is hard to understand, and that is likely why valuations aren't very high. On top of that, there are worries about commercial real estate markets, but in BN's case, these worries seem overblown to me, due to property-level debt, rather low loan-to-value ratios, and due to the high quality of BN's properties.
Fears can create buying opportunities, and I believe BN is a highly attractive investment today. Growth in asset management fees, the publicly traded offspring entities, and the insurance business should push profits higher, and in the meantime, BN can continue to buy back shares at an accelerating pace. At less than 10x trailing earnings, high-quality BN seems like a compelling pick to me.
For further details see:
Brookfield Corporation: Excellent Results Prove Massive Value