Brookfield Asset Management: Valuation Hinges On Growth Picking Up (NYSE:BAM)

Dear readers,

Brookfield Asset Management (NYSE:BAM) is one of the largest alternative asset managers in the world with assets under management (AUM) of nearly a Trillion dollars. The company received a lot of attention after it spun off from its parent company, the Brookfield Corporation (BN) because it gave investors a unique opportunity to invest in an asset light growth-oriented business promising a rare combination of a reasonably high dividend (4%+) and high growth (15%+).

I myself was quite excited to invest in this part of the Brookfield empire because it seemed like the most straightforward part of the business to analyze and with an enormous amount of ready to deploy dry powder, future earnings growth seemed almost like a sure thing. As I dug deeper, however, I came across some issues with the business model that I worried could threaten BAM’s ability to hit its ambitious growth targets.

You see, at first glance it seems as though the performance of BAM should be quite insulated from the ups and downs of the broader market. After all, they make the entirety of their money by charging base fees on invested capital and have no performance fees (a.k.a. carry). But the problem is that the base fees are charges based on AUM, and that fluctuates as the market goes up and down. These fluctuations are particularly pronounced for Brookfield’s publicly traded funds – Brookfield Infrastructure Partners (BIP) and Brookfield Renewable Partners (BEP).

Both of these funds are interest rate sensitive, so naturally their prices were under severe pressure over the past two years. As a result, the AUM invested in these funds has shrunk and so have the base fees.

I covered this dynamic in detail in my last piece in March, titled Growth Is Down As Expected, Will The Price Hold Up? and showed that during Q4 2023, base fees from BIP and BEP have declined by 5% YoY and 19% YoY, respectively. And as a result, the overall earnings growth in 2023 came in at just 8%, deeply below the target 15-20% growth that management has been guiding towards.

Regardless, the stock was trading at an all-time high valuation of 31x Fee-related earnings, much above my fair value range for alternative asset managers of 20-25x FRE. At such a rich valuation I chose to issue a SELL rating, which has turned out to be the right call, as the stock has returned a negative RoR of 1.5%, compared to an RoR of 7.6% of the S&P 500 (SPX) over the same period.

Since then, the company has reported another quarter of results and the macro picture has improved rather significantly, which may partly justify BAM’s high valuation multiple. Today, three weeks before Q2 2024 results will be released, I publish an update to my thesis to help you decide whether to buy the stock ahead of earnings.

Growth continues to slow down

The most recent results (Q1 2024) revealed a lot of the same themes that we saw at the end of last year. High-interest rates have put substantial pressure on the fundraising environment, which has led to another relatively poor quarter of fundraising of just $20 Billion with the majority, once again, coming from Credit.

Fundraising has been low over the past 12 months with total inflows of less than $70 Billion (under 7.5% of AUM) and to make things worse has been partly offset by (1) non-negligible outflows of $18 Billion and (2) $16 Billion in distributions. Combined Fee-bearing capital increased $27 Billion over the last twelve months, representing Fee-bearing AUM growth of just 6% YoY, down from 8% last quarter and miles below the target growth of 15%+.

In addition to low fundraising and significant outflows, the results also continued to be negatively impacted by BIP and BEP, which continue to trade at low prices and therefore contribute less in base fees than previously. Both funds posted slightly lower base fees in Q1 2024 than they did in Q4 2023 and showed negative YoY growth of 2.3% and 14%, respectively.

My expectation is for these funds to continue to cause a drag on earnings until the share prices of those funds recover, which will depend heavily on interest rate expectations. I recently shared an article arguing that I expect inflation to fall below the Fed’s 2% target in the second half of the year, and consequently expect rates across the yield curve to drop. If this scenario plays out, then next year, BIP and BEP could very well return to being a net positive for Brookfield.

Following a Fee-related earnings margin compression from 58% to 56%, BAM only managed to grow its FRE (the most important metric for valuation) to $2.37 Billion over the last twelve months. That’s earnings growth of only 3%!

What’s next?

BAM’s growth has essentially come to a halt as a result of poor fundraising and high-interest rates. But there are some positives here. Most importantly, the company has over $100 Billion in dry powder (i.e., uncalled commitments), half of which is not yet accruing fees. What this means is that there is at least $500 Million of embedded earnings potential as long as the company can put that money to work.

And Brookfield has a very good track-record of identifying profitable investments to deploy money into. Sure, over the past twelve months deployment has been low around $15 Billion per quarter, mostly in Credit. But this could very well be a result of an unfavorable macro environment and the firm simply waiting for a better time to deploy those funds.

By now, we know that growth will be quite low this year. Following earnings growth of just 6%, consensus calls for no more than 5.7% this year. What really matters to the investment though, is what will happen beyond 2024. And that is mostly a matter of Brookfield’s ability to deploy its dry powder and ideally also attract new capital. So far, analysts are optimistic and expect a sharp rebound in growth next year, right to the middle of management’s guidance of 15-20%. I am, however, cautious, because I have seen many instances of companies promising to return to growth next year, only for the goal to continue to get pushed forward and for earnings estimates to gradually come down (as they have for this year).

Bottom line

I fully expect BAM to grow its AUM and FRE in the mid to high-single digits this year. I also think that rates could decline more than expected in the second half of this year, which should have a favorable effect on base fees from BIP and BEP, which are not yet priced in.

Unfortunately, at a forward P/E of 28.5x the market is essentially pricing in a return to the 15-20% growth trajectory by next year. While that may happen, it’s far from certain. Therefore, I would require some sort of a discount (say a forward P/E of at least <25x) to account for this uncertainty. With BAM being priced for perfection, I rate the stock a SELL here at $41 per share.