Brookfield: Diversification, Dividend Growth And Promising Total Returns

| About: Brookfield Asset (BAM)

Summary

BAM has a fantastic record of delivering value to shareholders.

An investment in BAM gives exposure to it's four listed entities - BPY, BIP, BEP, BBP.

The company has been growing fee-bearing earnings and funds from operations at phenomenal rates.

They also have a fantastic CEO in Bruce Flatt, who has lead the company since 2002 and spearheaded their tremendous success.

Other than a slight issue with overvaluation, this company is a fantastic business. Buy on the dips.

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Source: Brookfield Investor Presentation

Brookfield Asset Management (NYSE:BAM) is a global alternative asset manager whose specialty is investing in "real assets" - this is primarily property, renewable energy sources, infrastructure, and private equity.

Brookfield is a juggernaut in the asset management industry. With a 115 year history, investment presence in more than 30 countries, and ~$250 billion of assets under management ("AUM"), they have substantial clout and a wide following in the investment community.

In this post I'm going to outline all the reasons why Brookfield makes an attractive investment at today's levels.

Overview

Brookfield Asset Management and it's multiple listed entities are listed on both the Toronto Stock Exchange and the New York Stock Exchange. They are:

  • Brookfield Asset Management
  • Brookfield Property Partners LP (NYSE:BPY)
  • Brookfield Renewable Partners LP (NYSE:BEP)
  • Brookfield Infrastructure Partners LP (NYSE:BIP)
  • Brookfield Business Partners LP (NYSE:BBU)

The ownership structure between Brookfield Asset Management and each of the listed entities is as follows:

Click to enlargeSource: Brookfield Asset Management Corporate Overview

Brookfield Asset Management owns a portion (between 30% and 79%) of each listed entity directly, with the remaining ownership traded on the NYSE and TSX. A brief overview of each entity follows.

Brookfield Asset Management Inc.

Brookfield Asset Management is a global alternative asset manager focusing on real assets. By real assets, think of large, illiquid investments that are out of the realm of traditional investors - bridges, water dams, ports, pipelines, and other large-scale investments.

Brookfield was founded in 1899 as "Brascan", a portmanteau of "Brazil" and "Canada" as the company was a Canadian owner and operator of Brazilian infrastructure. The company changed their name to Brookfield in 2005.

Investors deploy capital through Brookfield in three ways.

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Source: Brookfield Investor Presentation

The first is through private funds. These are available for institutional investors only, and are focused in real estate, infrastructure, and private equity. The second is through listed partnerships - more on these later, but the focus is on real estate, infrastructure, private equity, and renewable energy. The third way that clients invest through Brookfield is listed securities like preferred shares and Brookfield's common stock.

Brookfield Property Partners LP

This public subsidiary is Brookfield's real estate and property management arm. From their website:

"Brookfield Property Partners is a diversified global real estate company that owns, operates and develops one of the largest portfolios of office, retail, multifamily, industrial, hospitality, triple net lease and self-storage assets."

BPY has $146 billion of AUM according to their Q2 investor presentation. Brookfield Asset Management has a 62% stake in Brookfield Property Partners.

BPY is known for owning several landmark pieces of real estate across the globe. One of their most iconic assets is the Canary Wharf property in London, England. They also have key holdings in Toronto, New York City, Berlin, Sydney, and Perth:

Click to enlargeSource: Brookfield Property Partners Q2 Investor Presentation

Brookfield Renewable Partners LP

From their website:

"Brookfield Renewable Partners owns and operates one of the largest independent renewable power businesses globally with 260 generating facilities in North America, South America and Europe."

This partnership has impressive operational scope - in corporate profiles they often assert their status as a mover and a shaker of the renewable energy industry. In their September Corporate Profile, they announced $25 billion of renewable energy assets with 10,700 Megawatts of power generating capabilities. Most (88%) of this energy production is hydroelectric in nature.

Brookfield Asset Management has a 61% stake in Brookfield Renewable Energy Partners LP.

The total return of this listed partnership over time has been very favorable:

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Source: Brookfield Renewable Partners Investor Presentation

As an investor, one of the key points of interest for BEP is the stability of their earnings. This is because most of the partnership's revenues are contractual in nature - 90% of their revenue is contracted versus 10% which is merchanted. So as long as management has prudent cost-management policies, earnings should not decrease meaningfully in any reporting period (this applies to sequential earnings, but even more for year-over-year results).

Brookfield Infrastructure Partners LP

From their Q2 Investor Presentation:

"We are an owner and operator of critical and diverse infrastructure networks over which energy, water, goods, people and data flow or are stored."

Brookfield Infrastructure Partners LP has ~$14B of assets. Brookfield Asset Management has a 30% stake in Brookfield Infrastructure Partners LP.

Of all the listed partnerships from the Brookfield family, the infrastructure partnership has had the best total returns since inception:

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Source: Q2 Investor Presentation

I like BIP because their business is very easy to understand relative to the other listed partnerships. They own capital-intensive assets that are critical components of the economy and these pieces of global infrastructure generate healthy cash flows which can then be reinvested back into the partnership. The returns are also very impressive.

Brookfield Business Partners LP

Brookfield Business Partners is the newest listed entity in the Brookfield family. Investors in the parent company Brookfield Asset Management (myself included) were informed on May 16, 2016 that they would be receiving 1 unit of BBP for every 50 shares of BAM.A - for investors with odd lots, cash dividends would be received in lieu of fractional ownership.

Now what exactly is the purpose of this listed entity? Essentially this unit fills the role of a publicly-listed private equity vehicle for Brookfield investors.

From their website, they seek to invest in companies with "high barriers to entry, low production costs and the potential to benefit from Brookfield's global expertise as an owner and operator of real assets." This screenshot further elaborates on the business model of this listed entity:

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Source: Brookfield Business Partners Investor Presentation

Brookfield Business Partners is sector-diversified in terms of book equity, total assets, total revenues, and funds from operations ("FFO"):

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Curious how they define FFO? Well, according to the Brookfield Business Partners' website:

"Company FFO is defined as net income attributable to unitholders prior to non-cash valuation gains/losses, impairment charges, depletion, depreciation and amortization, and deferred income taxes."

In terms of operational diversity, BBU operates in three main industries - construction, energy, and industrial manufacturing.

Brookfield Business Partners has a very significant concentration in the construction sector, where they operate under the banner Brookfield Multiplex. Originally called Multiplex, this subsidiary was purchased by Brookfield in 2007 and forms the core of BBU's presence in the construction industry.

They are also active in the energy sector through ownership of Ember Resources and Insignia Energy in Alberta, Quadrant Energy in Australia, and CWC Energy Services Corporation in the Western Canadian Sedimentary Basin ("WCSB").

Their industrial manufacturing presence is composed of five key holdings - GrafTech, a manufacturer of graphite products; MAAX Inc., a manufacturer of bathroom accessories; North American Palladium Ltd., a precious metals company; Armtec, a precast concrete supplier; and the Hammerstone Corporation, a limestone company.

Now that I've done a deep-dive into Brookfield's business model, I'm going to propose my investment thesis. It's centered around BLANK key points:

  1. A Proven Record of Generating Wealth for Shareholders
  2. Instant Diversification
  3. A Safe and Growing Dividend
  4. Operational Excellence and Fantastic Management
  5. Favorable Industry Dynamics
  6. A Reasonable Valuation

A Proven Record of Generating Wealth for Shareholders

Here I'm going to examine a few metrics to demonstrate that Brookfield's management has historically delivered value to shareholders.

First let's consider the total return of the stock in recent years.

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Source: Yahoo! Finance. Note: returns are for the Canadian listed common stock.

Brookfield Asset Management's common stock has dramatically outperformed both the S&P 500 Index and the S&P/TSX Composite Index.

Breaking returns down to a more granular level, it is easy to see that each of Brookfield's listed entities are also outperforming the overall Canadian stock market:

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Now, past performance is not an indicator of future results, so why should we trust that Brookfield will continue to grow at satisfactory rates?

There are five other factors.

Instant Diversification

Diversification is an important factor for proper portfolio construction. Due to Brookfield's geographic and business sophistication, investors are given exposure to various markets - providing both geographic diversification and sector diversification. The following slide from an investor presentation summarizes the business' geographic diversity, both by AUM and employee count:

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Source: Brookfield Investor Presentation

The following picture gives a breakdown of private fund capital by geography.

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Source: Brookfield Investor Presentation

Obviously Brookfield's biggest presence is in North America. This is followed by 34% in their Asia, Middle East, and Australia region, and 7% in Europe & Other.

By having this level of diversification, an investment in Brookfield has a low probability of being negatively effected by any single event. For example, the wildfires in Fort MacMurray hurt the Canadian banks and insurers due to the resulting insurance claims. With tentacles reaching into so many aspects of the global economy, this type of event is unlikely to ever happen for Brookfield.

A Safe and Growing Dividend

Brookfield Asset Management currently pays a US$0.13 quarterly dividend, leading to an annual payout of US$0.52 for a yield of ~1.46%. On the TSX, exchange rates translate this to a yield of ~1.45% according to Yahoo! Finance.

Given that the S&P 500 dividend yield is 2.05% and the current 10-year government bond yield is ~1.70%, Brookfield Asset Management is clearly not a high yield dividend stock. I argue that there are two areas through which Brookfield's dividend overcomes their less-than-spectacular yield.

The first is the safety of the dividend. There are two ways to consider Brookfield's payout ratio - by comparing dividends paid to net income, or by comparing dividends paid to funds from operations ("FFO"). The results are dramatically different. In Q2 2016, Brookfield paid $0.13 in cash dividends*. This compares to:

  • $0.15 of net income, for a payout ratio of 87%
  • $0.62 of FFO, for a payout ratio of 21%.

For the six months ending in Q2 2016, Brookfield paid $0.26 in dividends. This compares to:

  • $0.38 of net income, for a payout ratio of 68%
  • $1.30 of FFO, for a payout ratio of 20%

Depending on which you consider accurate, the dividend is either at risk (based on net income) or very safe (based on FFO). I consider FFO to be the more accurate metric, and so I believe their dividend is very safe. Here's why.

Recall from the BBU corporate overview that Brookfield defines their FFO as follows:

"Company FFO is defined as net income attributable to unitholders prior to non-cash valuation gains/losses, impairment charges, depletion, depreciation and amortization, and deferred income taxes."

Brookfield Asset Management owns assets that generally appreciate in value - so adding back depreciation to calculate FFO, and measuring the business that way, makes perfect sense to me.

This brings us to my next point. Because Brookfield currently pays a low amount of their FFO as dividends, they have plenty of room to grow their distributions. They also have a decent track record of dividend increases - the growth from $0.35 in 2011 to $0.47 in 2015 represents a CAGR of 6%, well outpacing the rate of inflation. Retired investors need not worry that their income will erode over time if they are invested in Brookfield Asset Management.

*They also paid the special BBU dividend during this time period, which will be ignored for the purpose of calculating payout ratios.

Operational Excellence and Fantastic Management

Brookfield is a leader in their industry, and are known for being very good at what they do.

From a management perspective, it starts at the top with CEO Bruce Flatt. After being appointed the CEO of Brookfield (then under the name Brascan) at the ripe young age of 37, Flatt has transformed the company by shedding assets and giving birth to the asset-light business model that Brookfield is known for. With total investment returns of 1000%+ since 2002 (Flatt's first year as CEO), investors are happy.

Operationally, Brookfield demonstrates a similar form of excellence. They execute in ways that are incapable of being replicated by any of their competitors - this is due to three unique features of their business model.

First, Brookfield's use of listed entities to raise capital allows them to increase AUM at a faster rate than this competitors. This allows them to grow their share of the institutional investment market. Similarly unique to how Vanguard is owned by the investor's of it's funds, Brookfield's accumulation of capital through listed entities gives them a special competitive advantage.

Secondly, Brookfield has a uniquely long time horizon granted by the fact that their investors are either institutional or contributing capital through entities listed on stock exchanges. Long-term orientations are tremendously important.

"The single greatest edge an investor can have is a long-term orientation."
- Seth Klarman

The third aspect of their business model that leads them to excellence is not unique like the other two, but it is equally important. Brookfield invests capital alongside their clients, which serves two main purposes. Obviously Brookfield gets to reap the investment returns, just like their investors, but more importantly this aligns the interests of Brookfield with those of their investors. This is very important and something that should be noticed and recognized by investors and customers alike.

Favorable Industry Dynamics

Brookfield is set to be exposed to some very favorable industry dynamics in the coming years. Consider the following:

  • The 10-Year Canadian bond yield is ~1.17% (up from 0.95% earlier this year)
  • The 10-Year US bond yield is ~1.70% (up from 1.35% earlier this year)
  • The S&P 500 dividend yield is 2.05%

Although I've mentioned a few of these points in other parts of this article already, the bottom line remains the same - attractive sources of income are nowhere to be found.

As a result, investors (particularly those that are institutional in nature) are seeking alternative asset classes to boost investment returns. In the 2020s, Brookfield expects >40% of institutional allocations to be in "real assets" (their specialty):

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Source: Brookfield Investor Education

More allocations to real assets will increase Brookfield's aggregate AUM, which will trickle down into other investment metrics - revenues, funds from operations, and earnings will all increase as a result, leading to superior investment returns for their shareholders.

A Reasonable Valuation

Here I'm only going to be discussing the valuation of the parent company Brookfield Asset Management.

On the NYSE, Brookfield is currently trading at $35.59. This represents a price-to-earnings ratio of 27.53 (based on TTM earnings per share of $1.29) and a price-to-book ratio of 1.578 (which is in line with it's average over the past few years).

On the TSE, Brookfield's most recent close was at $47.26. This relates to a price-to-earnings ratio of 36.55 based on a TTM earnings per share of $1.29. Clearly, the company is a better value when purchased in American dollars.

According to a recent post on The Cerbat Gem, the average 1-year price target among the twelve brokerages covering the firm is $40.18 (in US dollars). This represents ~13% upside from today's level, excluding dividends.

Personally, I don't view Brookfield's shares as a fantastic value right now. If you compare Brookfield's US P/E ratio of 27.53 to the S&P 500's P/E ratio of 25.03, then clearly investors are paying a growth premium. This is understandable for a company that is rapidly growing fee-bearing capital and expanding into new markets with the public launch of Brookfield Business Partners.

Taking all valuation metrics into account along with the company's growth prospects, my advice is to buy on the dips (particularly for the Canadian shares, which look to be less attractively valued).

The Bottom Line

With an investment in Brookfield Asset Management, I believe one can expect two things.

First, instant diversification. Investors are immediately given exposure to the four listed entities, creating a pass-through investment in the real estate, infrastructure, private equity, and renewable energy sectors. Additionally, Brookfield invests in ~30 countries, so owners of Brookfield common stock are exposed to all kinds of exciting geographies.

Secondly, I expect total returns from Brookfield that exceed the returns of the aggregate market. The company, with it's ~USD$35 billion market cap, is small enough to still allow for substantial growth. They are led by a value investor who's been called the "Warren Buffett" of Canada - Bruce Flatt. Brookfield also has such a huge economic moat - their expertise in the management of real assets has led to a substantial competitive advantage. All of these things lead me to believe that Brookfield Asset Management will continue it's record of delivering total returns that outpace the overall stock market, both in Canada and the United States.

Readers - what are your thoughts on Brookfield? Are you long - or more interestingly, are you short? Where do you see this company in ten years? Let me know in the comments section!

Disclosure: I am/we are long BAM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.