2023-06-14 06:26:17 ET
Summary
- Brookfield is a large asset-heavy manager with holdings across private equity, private credit, real estate, and infrastructure.
- The stock has fluctuated this year and is trailing the S&P 500, although it has picked up momentum recently.
- This is quite likely due to a significant buyback reauthorization that will eliminate an entire 10% of the company's float over the course of the year ahead.
- Additionally, Brookfield has solid comparable metrics. While quite leveraged, its ROA indicates continued efficiency in using capital.
- Together these factors make it a good buy for the year ahead.
Overview
Brookfield Corporation ( BN ) is a Canada-domiciled asset manager focused on private equity and private credit investments. The firm is quite large and operates with a global footprint, currently managing more than $825B in capital. On its own it can be considered an asset-heavy asset manager in that it funnels most returns back into its funds instead of paying them out to shareholders. However, this is not the full picture. Brookfield also wholly owns a subsidiary called Brookfield Asset Management (NYSE: BAM ), a vehicle which contains its asset-light funds. As a result BAM pays a higher yield, although the disparity between these yields (0.87% for BN and 1.96% for BAM TTM) is not particularly high. Overall Brookfield's business is a hybrid of these two types of asset management operating models.
Brookfield stock has had a volatile journey this year and has only generated 3.48% in total returns, well below that of the S&P500. While starting the year off strong Brookfield saw its shares sell off significantly, then clawing back some of its losses while continuing to trail the S&P. Recent weeks are seeing fresh upward momentum in the stock price.
Recent appreciation appears to be driven by the company's renewal of its buyback program . This repurchase authorization (or 'normal course issuer bid' as per Canadian market parlance) is significant, amounting to 10% of the company's float. This has been authorized to proceed through to May 24 2024. I'll mention off the bat that this is a big buyback; it is very rare to see a company buy back an entire 10% of its float over the course of a year. We should certainly keep this factor in mind as we review the stock. With that said, I'll review Brookfield's financials and compare them to those of its peers in order to see if its stock is a buy.
Comparative Financials
As mentioned Brookfield is an asset-heavy firm that also has an asset-light subsidiary. Since these are two distinct securities, however, and we are here focused on the main entity BN, it makes sense to restrict our comparisons to its asset-heavy peers. There are four publicly-traded scale players that fit the bill here. By market cap, Brookfield is the largest of the four as of this article.
First taking a look at revenue growth across the bunch, we see that Brookfield had the 2nd-best performance in this regard over the prior year. These numbers are exceptionally volatile, however, and we can't read too far into this. This is often the case for investment businesses of this nature.
As such, I think that the long-term CAGR here is more interpretable. This is because a compound growth rate over a multiple year span can smooth out what would otherwise be highly variable year-over-year growth. The numbers we have here are current consensus expectations and form a good comparative metric across the firms. Unfortunately Brookfield does not bring much to the table in this regard. It is dead last on a 3 year forward basis. Over the next 5 years, the expected compound revenue growth rate for Brookfield looks materially better, jumping to 2nd in the space by a good margin. This implies that growth will pick up significantly after 3 years.
This is an interesting set of numbers to interpret. I think these relatively conservative expectations over the next 3 years are good because it can lead to beats against consensus earnings, which are a reliable driver of share price increases. Over the 5 year span a CAGR of close to 15% is nothing to scoff at. If Brookfield can manage smoother growth over longer durations than its peers, it can still do very well long-term.
Continuing on to profitability we can note a similarly volatile picture across these four firms. Just as with revenues there is going to be significant volatility y/y for companies in this line of business. Nonetheless, Brookfield's net margin of 0.85% over the past year is not a good showing. The upshot is that it isn't negative like some of its peers.
This can also be said about its ROE and ROA return metrics. It seems that Brookfield has been just barely squeaking out a profit over the past year. This performance is nonetheless far above the median in terms of its peers. I'll also note that it has continued to generate positive free cash flow, which two of its competitors were not able to maintain this past year. I think that overall these profitability numbers aren't particularly exciting for investors but should be contextualized as beyond the median in the space. That makes them good on a relative basis.
Given relatively weak performance across the space as a whole this past year, the balance sheet takes on new import. The balance sheet can either hamper or help profitability, all the more so in the context of a company managing external capital. Here we can see that Brookfield is quite leveraged, well beyond that of its peers. The company has by far the largest amount of debt in its sector at $173.48B. Even with no short-term debt in its capital structure, the interest on this amount is driving current liabilities up. This yields a current ratio of 0.62. The quick ratio, which includes all assets and liabilities, is even worse at 0.39.
Brookfield's balance sheet looks relatively stretched, and it also has less cash on hand than its similarly sized peers. On the other hand it is also continuing to generate free cash flow, which Apollo ( APO ) and KKR ( KKR ) have not been doing over this past year. Its return on assets, which accounts for liabilities/leverage, also remains solid at 2.29%. Given that I think it can be considered fair for now.
The cash flow statement is where Brookfield outperforms its peers. It has the highest net operating cash flow in the space as well as by far the highest levered free cash flow in the space. In terms of levered FCF, there is no comparison; Brookfield is the market leader at the moment.
Something else to note here is Brookfield's significantly higher levels of capital expenditure. It has been investing significantly this past year. This is also driven by the company's relatively significant infrastructure business, an understandably capital intensive area of investment.
Since free cash flow is such a salient metric in the current market, this aspect of Brookfield's operations makes it look a lot better than many of its other comparables. Given the apparent downturn overall in the space over the past year, Brookfield's continued ability to generate significant cash flows amounts to a strong indicator as to the resilience of its business.
Valuation and Risks
To first comment on risk, I think that the core risk facing this business comes down to the rate spread. That is, the spread on the rate it pays for its capital versus the rate that it gets on its capital. For asset-heavy managers with significant leverage this is the very essence of business performance. Brookfield relies on being able to get funding relatively cheap and distribute debt relatively dear. To date it appears to be managing this well, with a good return on assets metric and the aforementioned strong performance on free cash flow generation. This picture is made much more complex because of the shifting balance between holdings in private equity and private credit.
This then becomes a matter of duration. Debt issued in a high-rate context, such as now, is going to have a proportionally higher rate as compared to debt issued in a lower-rate context. If the Federal Reserve reverses course again, they could rapidly compress interest rates on new issuances market-wide. If Brookfield is caught holding exposure that costs more than it can earn, it will be facing down trouble. This never plays out immediately because there will be returns flowing in from older investments.
For indicators of this risk beginning to accrue I would pay attention to fluctuations in the ROA and the overall level of interest payments that the firm is making. Currently I will be clear in saying this problem has not yet presented itself.
We can now turn to valuation and see how the market is pricing Brookfield's prospects. It is best to stick to GAAP numbers due to accounting disparities between firms when it comes to non-GAAP metrics. Here Brookfield looks good. It is trading at only a 10.39 forward P/E as of this article, close to its much-smaller peer Carlyle. KKR is priced more than twice as expensively, and Apollo doesn't even have a GAAP profit to show for the year ahead.
Conclusion
Overall I am seeing a combination of two forces here that net out quite favorably: cheap forward valuation, and a big buyback. As mentioned Brookfield is purchasing 10% of its entire float from May 2023 to May 2024. We can readily determine the price impact of this by calculating Share Price as Market Capitalization/Total Shares, holding market cap constant.
Since we are treating Market Cap as a constant, we can substitute 1 for the number. Since we are getting 10% less float, new total shares will be 0.9. We then divide 1 by 0.9 to get an 11.1% gain. This means that Brookfield's current buyback program will increase share prices by 11.1% between May 2023 and May 2024, all else held equal. At the end of May 2023 the share price was $30.05, implying a new share price of $33.39. At today's price $32.70, it seems that most of this is already baked in. We can't determine, however, how much of this recent buying was by the firm and how much by investors. Since buyback programs tend to proceed in a structured fashion, with roughly equal amounts in intervals over the assigned timeframe, I am inclined to believe that some of this was investor buying. This implies more room to run.
Additionally I like Brookfield at the moment because of its ability to generate cash flow, something it is doing better than the rest. This presents a clear portrait of performance, all other metrics aside. Considering all of this together I think Brookfield is a good buy for the year ahead.
For further details see:
Brookfield: Good Buy Due To Heavy Buyback And High Free Cash Flow