Written by Bob Ciura on April 12th, 2017, for Sure Dividend.
Investors looking for high yield in the financial sector typically have to look beyond the big banks and insurance companies. While there are several financial stocks represented in the Dividend Achievers, they mostly have dividend yields in the 2%-3% range. The Dividend Achievers includes 265 stocks that have raised their dividends for at least 10 years in a row. You can see the full Dividend Achievers List here.
Oaktree Capital Group (NYSE:OAK) is not on this list, because it has an uneven dividend history. It pays a variable distribution, which fluctuates depending on the performance of the business. But it has a high dividend yield of 5.2%, which is well above the financial sector average yield.
This article will discuss Oaktree’s business model and future growth prospects.
Oaktree is an asset management firm, with a focus on alternative investments. It seeks a superior return with a lower level of risk than standard investment options can generate. Some of the asset classes the firm invests in include corporate debt, distressed debt, real estate, and more.
Source: 2017 Quarterly Investor Presentation, page 3
Oaktree’s fund types include both open-end and closed-end, and evergreen funds. The company has offices in 18 cities around the world. At the end of 2016, the company held $101 billion in assets under management. It has a diverse client base, which includes pension funds, insurance companies, corporations, endowments, and high net worth individuals. It also has a 20% ownership stake in DoubleLine Capital.
Oaktree’s funds have performed well over the past several years, which has driven growth of assets under management.
Source: 2017 Quarterly Investor Presentation, page 5
For example, AUM rose 4.1% last year, and grew 35% over the past five years.
Oaktree is structured as a partnership. This means its investors are considered unitholders, and the company pays a distribution. The benefits of the partnership structure are that the company is generally not subject to federal or state income tax. Instead, the unitholders—often referred to as partners—are required to report their share of income. Partnerships tend to offer high dividend yields, but do present more complex tax implications. Unitholders receive a K-1 form for tax reporting.
Rather than utilizing standard GAAP earnings per share, Oaktree reports in terms of distributable earnings. This figure excludes various non-recurring items that can skew GAAP earnings. It is a similar metric as distributable cash flow, which is typically used by MLPs. In 2016, Oaktree generated distributable earnings per unit of $2.94, up 22% from $2.42 in 2015. Last year was a very strong performance for the firm.
Source: 2017 Quarterly Investor Presentation, page 22
Growth was due to higher assets under management, increasing fees, and higher incentive income.
Future growth will be augmented by the company’s record fundraising last year. Oaktree saw a 22% increase in fee-related earnings in 2016. New products, such as the Opportunities Funds X/Xb and European Principal Fund IV, fueled $6 billion in closed-end fundraising last year. This drove 4.2% growth in management fees in 2016.
Continued growth is likely, because the company has a lot of "dry powder" left, meaning unallocated funds that have yet to begin generating fees.
Source: 2017 Quarterly Investor Presentation, page 13
As of December 31, 2016, uncalled capital commitments stood at $20.8 billion. Of this, $13.5 billion was not yet generating management fees.
The company’s pipeline of future products is robust, with additional real estate and debt funds lined up for 2017.
Separately, a more lax regulatory environment from the new administration is also a potential catalyst. Any de-regulation of the financial industry would likely be a plus for Oaktree moving forward, although how that exactly takes shape is unclear.
Competitive Advantages & Recession Performance
The biggest competitive advantage in the investment industry is performance. This drives the reputation of the firm. In order for an investment manager to generate high fees, it needs to show its clients that its fees are justified. Oaktree’s performance has been strong for a prolonged period, which has provided the impressive growth of assets under management and distributable earnings.
One consideration for investors is that the company’s results could be volatile going forward. As shown in the above image, distributable earnings have fluctuated in recent years. Going forward, a recession would likely hit Oaktree particularly hard. Oaktree began trading publicly in 2012, so its financial performance during the Great Recession is unclear. That said, it is a reasonable assumption that the company would suffer during a recession. The financial performance of investment management firms is correlated with the performance of the markets. A recession naturally causes markets to decline, which would likely cause Oaktree’s assets under management—and fees—to decline as well.
Valuation & Expected Returns
Valuing Oaktree in terms of distributable earnings reveals that the stock is modestly priced at the present time. Based on 2016 distributable earnings per unit of $2.94, Oaktree trades for a price-to-earnings ratio of 15.8, which is below average. The S&P 500 Index has an average price-to-earnings ratio of 26. Given the company’s growth in assets under management, there could be room for the valuation multiple to expand.
Aside from an expanding price-to-earnings ratio, the stock will generate returns based on earnings growth and dividends. Oaktree pays a quarterly distribution to unitholders. In the past four quarters, the company distributed $2.41 to investors. Based on its current share price, Oaktree has a 5.2% dividend yield. This is a very high yield, which is more than double the average dividend yield of the S&P 500 Index. As a result, the dividend should make up a large portion of Oaktree’s future returns. With such a high yield, it would not be difficult for Oaktree to generate double-digit total annualized returns.
Oaktree’s distribution is covered by earnings. Last year, the company generated distributable earnings per unit that covered its dividend payout, by 1.22 times. Put differently, the company generated 22% more distributable earnings than it needed to pay its distribution. This leaves room for a modest distribution increase in 2017, provided that business conditions do not deteriorate. Of course, a recession in 2017 or 2018 would change this outlook.
Investment management firms can be riskier stocks than big banks or insurance companies. Their performance is reliant almost entirely on the talent of their portfolio managers. When fund performance is strong, assets under management and related fees can grow at a high rate. However, when performance suffers, investors can rush for the exits. An example of the latter is Franklin Resources (NYSE:BEN), which is struggling with falling assets under management, due to poor performance of a few of its flagship funds.
If the U.S. stays out of recession moving forward, Oaktree should continue to grow, thanks to its strong fund performance over the past several years. However, investors looking for lower-yielding bank stocks that come with a bit less risk should consider Wells Fargo (NYSE:WFC) or JPMorgan Chase (NYSE:JPM).