- BAM is trading close to its fair value which is far lower than the "plan value" promoted by Brookfield.
- BEP is not appealing at the current price level.
- BIP will grow faster and is less expensive than BEP.
- The expected Brookfield Reinsurance spin-off should be of interest to investors in BAM.
Source: Brookfield. After a very successful year for BEP, some investors anticipate its endless expansion and publish articles with enticing titles such as "Brookfield Renewable Sees a More Than $100 Trillion Opportunity Ahead" (I have not read it). Who could be the ultimate beneficiary of this expansion?
It has been about half a year since I posted about NYSE:BAM. Meanwhile, the company and its subsidiaries reported their tumultuous 2020 and outlined further plans. I guess it is time to revisit.
As usual, BAM calculated its own "plan value" for its shares. The latest figure came up at $66 vs. about $40-42 quote at the time of writing. You may ask: Why wouldn't BAM snap its undervalued shares with about $70+B of group-wide liquidity? Well, the answer is obvious: BAM is not relying on the "plan value". In the past, I explained several times why the "plan value" has little to do with the company's intrinsic value - please refer to my previous publications for details.
The "plan value" is a good PR tool that makes BAM's shares perennially undervalued. Brookfield talks up its shares but is not in a hurry to repurchase them materially. Berkshire Hathaway (BRK.A) (BRK.B) is doing exactly the opposite: instead of talking up shares, it buys them back. Otherwise, BAM is a value investor no less than Berkshire. What can explain the difference? Besides motives related to the management compensation, BAM as a company benefits from high share prices in two ways.
Under certain circumstances, BAM is ready to issue additional shares. This is something that Berkshire is reluctant to do and has not done for many years. The last time BAM issued shares was for the Oaktree acquisition in 2019 making the deal palatable for certain Oaktree shareholders. It was Mr. Flatt's masterstroke that helped BAM a lot in 2020 and will remain a growth lever for many years to come.
Secondly, BAM's subs constitute a significant part of the company's value. It is twice beneficial for Brookfield to talk up its own price by talking up subs' valuations in the process: BAM's management fees are proportional to subs' market caps. As many BPY shareholders have learned the hard way it is not profitable to trust "plan values". To value BPY, BAM used its IFRS book value instead of the market price. For all other subsidiaries, it was exactly the opposite. In other words, measurement rulers varied depending on which one would produce the highest number.
When BAM shares are truly and significantly undervalued over some prolonged period, the company will not hesitate to buy them back big.
Another Way to Value BAM
As my readers know, I am using TTM operating FFO for this purpose that BAM updates every quarter in its Supplementary. This is not the only suitable metric but I will again refer to my older publications for explanations.
The table below can help us to gauge what is going on (the Quote column is not adjusted for the 2020 split).
Source: author's calculations and BAM's filings
The average P/Oper. FFO multiple is about 17 and based on this static measure, BAM seems to be overvalued. However, we have to consider important circumstances specific for the unusual 2020:
1. Interest rates are currently lower than at any other point in the table and justify higher multiples.
2. The pandemic has negatively affected the cash flows and valuations of certain parts of the Brookfield empire in 2020. BPY immediately comes to mind but the same is true about BBU and, to a much smaller extent, about BIP. It also slowed some dispositions that were supposed to happen in both private and public investment vehicles. So, both invested capital and asset management FFO (as well as realized carry) were affected. This situation got mostly normalized towards the end of 2020 but is still present in full-year results.
3. 2021 may become a record-setting year for raising third-party fee-bearing capital.
I am hesitant to slap hard numbers on these factors. But when you take them into account, BAM, in my opinion, is trading close to its fair value. It might be slightly undervalued but is not a screaming bargain. When buying BAM at its fair price you can count on a 12-15% annual return that the company promises and delivers. Alternatively, you can wait for a moment of undervaluation like last October when BAM was available below $30. But it might be a long wait.
The story of BPY is not finished yet. It is currently trading at $17+, above $16.50 that BAM offered. Based on previous similar transactions, BAM will bump up its offer but not by much. So, the final offer may be close to BPY's current price and the shareholders are expected to accept it. Their alternatives are not very exciting: if the offer is not accepted, BPY shares are likely to plunge. I am not sure that BAM's offer is so bad for BPY's shareholders despite some publications (and even lawsuits) claiming it. It will take a lot of effort within the more forgiving private environment to do something constructive with former GGP.
Recently, Bloomberg came up with some interesting material:
U.S. mall values plunged an average 60% after appraisals in 2020, a sign of more pain to come for retail properties even as the economy emerges from pandemic-enforced lockdowns.
Surely, mediocre properties were affected more than top malls. However, the article quotes significant haircuts for some of Simon's malls that are similar to BPY's in terms of quality. Eventually, BAM is expected to profit from the deal but this profit will be hard-earned.
Some limited arbitrage opportunity exists in BPYUP - preferred shares of BPYU, BPY's corporate twin. They are trading at about $24.75-24.85 and pay a 6.375% dividend. If the deal goes through, BAM will pay $25 within the next half a year or so. Not something particularly appealing but, perhaps, better than cash on a risk-adjusted basis.
Overall, BPY has been a failure for BAM. Since Bruce Flatt used to run BPY's predecessor before becoming BAM's CEO, it is probably a disappointment for him. Several years ago, it would have been a major blow to BAM but today, it is definitely manageable. In my older publication, I analyzed ramifications quantitatively and will not repeat them here. BAM is likely to adjust its real estate strategy based on Mr. Flatt's quote on Q4 20 earnings call:
And I think over time, we hope as we've communicated, to reduce our exposure to real estate over time, and it will be a combination of outright sales and creating new products.
In the absence of significant price dislocations, BAM should be a better stock than its subs since BAM receives management fees that subs pay. But sometimes, subs enjoy fantastic runs as happened with BEP in 2020. Renewable energy revolution, Mr. Biden's agenda, and TerraForm Power (TERP) acquisition propelled BEP units (and even more so BEPC shares) to unbelievable heights. Brookfield Renewable has become a household name and it is not uncommon to see publications with titles like "Brookfield Renewable Sees a More Than $100 Trillion Opportunity Ahead".
For BEP, all $100 trillion or whatever are concentrated in one number: distribution growth rate. This is a very important number since we expect a long-term return to be equal to distribution yield plus distribution growth rate. Multiples expansions or contractions can significantly distort this idyllic picture within shorter time frames.
In 2015, Mr. Sachin Shah became BEP's CEO and held this position until promoted to BAM's Chief Investment Officer towards the end of 2020. In my opinion, Mr. Shah was an outstanding CEO. During his tenure, he made BEP more dynamic by enabling development capabilities and diversifying from purely hydro into the wind and solar energy. The distribution growth rates during his tenure are presented in the table below (I am using historical figures from brookfield.com before adjusting for the 2020 split).
Source: author's calculations using BEP data
Now, what about $100 trillion? BEP has already utilized enormous opportunities in the renewable space and will utilize more in the future but the main beneficiary will be BAM. A lot of additional capital will be needed to build renewable facilities and this capital will be supplied by either BEP issuing additional units/shares or third parties via private funds. BAM, of course, will charge management fees on all this capital. I would not bet on BEP to increase distribution growth considerably and will explain more in the next section.
Let us now take a look at Mr. Shah's holdings within Brookfield's universe as presented below. Please make your own conclusions.
BIP and BEP
Does BIP differ from BEP? Structurally they are very much alike and both have enjoyed excellent management. But there are two important differences.
Being involved with oil, gas, and even coal, BIP is less "progressive" and fashionable than BEP. Its transportation segment was affected by the pandemic in 2020 while BEP was unscathed. Both factors make BIP cheaper than BEP currently while most of the time it was the opposite (please note that both companies are extremely expensive per traditional metrics).
As I showed in one of my previous articles, BIP can be easily valued by its distribution yield provided fundamentals are in place. By fundamentals, I mean primarily AFFO and return on invested capital. At the time of writing, BIP's distribution yield is 4.0% vs. 3.8% on average over the last 10 years at higher interest rates (for comparison, BEP's distribution yield is about 3%).
At the same time, BIP's distribution growth is higher when compared with BEP. Please take a look at the slide from BIP's corporate presentation below:
The last increase was only 5%, on par with BEP, because the pandemic affected BIP's transportation segment in 2020. Due to growing IDR payments to BAM, it is not realistic to expect historic 10% distribution growth in the future. Perhaps a more modest 7% or so is achievable though.
Why do I expect BIP to grow faster than BEP? Primarily due to its mandate: BIP can invest in many different industries while BEP is limited to renewables only. And this is a very expensive segment.
BIP can sell businesses in slower-growing industries at, say, 15-20 times FFO and invest in higher growing industries at 10-12 times FFO. For example, BIP recently partially exited the coal terminal business in Australia and closed the acquisition of mobile infrastructure in India. Surely, the difference in growth between the two is humongous. From time to time, Mr. Pollock (BIP's CEO) announces multiyear IRRs realized upon exiting and they are typically above 20%. For BIP, capital recycling is more profitable and easier to achieve than for BEP.
So, we have more dynamic BIP trading at lower valuations than less dynamic BEP. Which one is a better investment today? The answer is obvious unless you want to bet on another multiples expansion for renewables.
Besides traditional lines of business, BAM is in the process of entering new ones. Hi-tech is one of them and you can find a good review of this effort here. It sounds very promising but the scope, at least initially, will be very limited. Brookfield is not yet an expert in software and hi-tech in general.
We can expect quicker results in areas that Brookfield knows well: secondaries, energy transition, residential real estate development (this is not a new business but the presentation during Q4 20 call was impressive). But I am particularly interested in Brookfield Reinsurance. Several months ago, I published an article attempting to evaluate returns that BAM is counting on in the reinsurance business and they turned out higher than I expected. Moreover, Brookfield can achieve scale in this industry relatively quickly. We still do not know details about the spin-off of Brookfield Re expected shortly but this is something that can potentially influence BAM shares.
This article was written by
Analyst’s Disclosure: I am/we are long BAM, BIP, BPYUP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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