This Buffet-Munger Name Is More Growth Stock than Value Stock

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May 29, 2015
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When pension funds and big money managers want value propositions beyond the stock and bond markets, they call on companies like Brookfield Asset Management Inc. (BAM, Financial).

We might call it one of the 800-pound gorillas literally searching the world for under-priced assets, especially in real estate, renewable energy, and infrastructure (among others). Brookfield has more than $200-billion in assets under management, and a big war chest that will allow it to make major acquisitions when it finds properties it likes.

But, recent events have pushed down its share price, starting with gap down of about a dollar and a half on April 21, as shown in this Stockcharts chart:

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The day before, Brookfield had announced an equity offering of 17.9 million shares, with expected proceeds of just over $1 billion (on April 22 Associated Estates Realty Corporation announced it would be bought by Brookfield’s real estate fund for $2.5 billion, including the assumption of debt). That equity offering amounted to a dilution of roughly 2%.

According to the Buffett-Munger screener, BAM is currently under-valued, and capable of consistently increasing its earnings, making it a value stock. The following GuruFocus chart shows BAM’s share price (green line) and Earnings Per Share (EPS, blue line):

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With that, let’s take a closer look at Brookfield Asset Management Inc.

History

1899: The SĂŁo Paulo [Brazil] Railway, Light and Power Company founded; The Rio de Janeiro Tramway, Light and Power Company, another predecessor company, founded in 1904.

1912: Brazilian Traction, Light and Power Company Limited (the third predecessor) incorporated in Toronto, Canada as a public company. It’s objective is to develop hydro-electric power operations and other utility services in Brazil, and it also becomes a holding company for the two previous companies.

1969: Brazilian Light and Power Company Limited renamed Brascan Limited (BL).

2005: Company name changes to Brookfield Asset Management (BAM, Financial).

2007: Buys Multiplex Group construction company for $6.1 billion and renames it Brookfield Multiplex.

2008: Brookfield Infrastructure Partners L.P. (BIP) is spun out of the holding company.

2010: Brookfield Renewable Energy Partners (BEP.UN), a global renewable power company, goes public.

2010: Leads General Growth Properties, the second-largest U.S. shopping mall owner, out of bankruptcy.

2013: Spins off global property holdings through a new entity, Brookfield Property Partners (BPY).

History section based on information provided at Wikipedia.com.

Comments: Brookfield Asset Management began with Canadian investors creating transportation and utility companies in Brazil; through many acquisitions and divestitures, it has reshaped itself into a global player with a wider scope.

Brookfield’s Business

BAM is a holding company, and describes itself this way, “...a global alternative asset manager with over $200 billion in assets under management.” It laid out what it calls its ‘simple’ business model this way, in a presentation at the Annual General Meeting on May 6, 2015:

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In some ways, Brookfield Asset Management is simply an institutional value investor:

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It specializes in four key areas beyond the stock and bond markets (again, as laid out in the presentation at the 2015 AGM):

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Among its landmark projects is the Canary Wharf Group in London, United Kingdom.

Segments

For financial reporting purposes, BAM divides its business into five segments, or “operating platforms”:

  • Property
  • Renewable energy
  • Infrastructure
  • Private equity
  • Public markets business (managing portfolios of listed securities on behalf of clients).

Revenue

As the following excerpt from the Management Discussion & Analysis section of the Annual Report shows, Property is the biggest revenue generator:

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And this excerpt shows the geographic origin of revenues, with the United States supplanting Brazil as the company’s key market:

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Competition

Yahoo! Finance puts BAM into the Real Estate Development industry, and lists its competitors as two major Canadian pension funds, but as we’ve seen above, the company operates in various industries and in various countries. For example, it’s biggest area of operations is the United States, so perhaps we should include pension giant California Public Employees Retirement System (CALPERS) and other American pension funds as competitors.

In its Annual Report for 2014, the company reports it competes with other asset managers for public and private institutional capital, and that the competition is fierce. In this area, the key is investment returns, the ability to use capital profitably.

On the property side, it buys and then leases out high-quality commercial properties, which sees it competing with other landlords, as well as the owners in the hospitality and multifamily industries.

Much of the output from its renewable energy facilities (primarily hydro dams) goes into the wholesale electricity market, where it must compete with the output from other generators.

Other

Brookfield Asset Management Inc. is based in Toronto, Canada, and has corporate offices in New York and Toronto.

100 offices in more than 20 countries.

Listed on the New York (BAM, Financial), Toronto (BAM.A, Financial), and Euronext (BAMA, Financial) stock exchanges.

28,000 operating employees.

Unless otherwise noted, this section is based on information in the 2014 Annual Report and a presentation to the Annual General Meeting held on May 6, 2015.

Comments: Brookfield Asset Mangement operates as a holding company with numerous interests, including asset management, real estate, renewable energy, and infrastructure. The biggest contributors to the company’s revenue are property and asset management, and it faces significant competition in all areas.

Opportunities, Risks, & Growth

Opportunities

The assets of its institutional clients have been growing ‘exponentially’ and are expected to hit $70 trillion in the 2020s, up from $45 trillion in 2012. As assets grow, so does the need for management by companies by Brookfield Asset Management.

Investors generally are looking for long-term, risk-adjusted returns (bonds have not fit the bill since the 2008 Crisis), from assets that generate cash and capital returns. At the same time, they want lower volatility and some sort of hedging against inflation.

The company reports that it enjoys ‘elevated’ levels of liquidity, which means it is ready to make major acquisitions. In addition, it has access to both capital and borrowed funds at a reasonable cost.

BAM has a global footprint, allowing it to identify and invest in regions offering high growth or high returns.

Risks

As an asset management company, Brookfield must maintain its investment returns. While investors, and particularly institutional investors, might allow some slippage, any indication of longer-term underperformance would sent clients to competitors.

As a global company, risks include unfavorable currency fluctuations; the company notes that it hedges some of its financial exposures, but not all of it.

Laws, rules, and regulations have proliferated almost everywhere since 2008, and as an asset manager and property developer, BAM must continually identify and comply with them.

Economic conditions, which, as the company says, include but are not limited to “...credit and capital market volatility, business investment levels, government spending levels, consumer spending levels, changes in laws (including laws relating to taxation), trade barriers, commodity prices, currency exchange rates and controls, national and international political circumstances (including wars, terrorist acts or security operations), changes in interest rates, inflation rates and general economic uncertainty.”

Growth

The following GuruFocus chart shows how Brookfield Asset Management has grown its revenue (green line) and Earnings Per Share (blue line) since 1998:

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Further, the company says in its Annual Report, “...compound shareholder return over the last 20 years is 19%, which compares well with most other investment alternatives. This should instill some confidence in our ability to execute on our plans and enable us to achieve our goal of generating 12% to 15% compound returns over the longer term.”

In the presentation at its AGM, it provided this overview of its goal for growth:

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In the Annual Report, it breaks out the goal more specifically,

  • “Our strategy is to provide world-class alternative asset management services on a global basis...
  • “focused on real assets such as property, renewable energy, infrastructure, and private equity investments.
  • “Our business model utilizes our global reach to identify and acquire high quality assets at favourable valuations...
  • “finance them prudently, and then...
  • “enhance the cash flows and values of these assets through our established operating platforms....”

Unless otherwise noted, this section is based on information in the 2014 Annual Report and a presentation to the Annual General Meeting held on May 6, 2015.

Comments: Brookfield has a strong history of increasing its earnings, and seems well positioned to hit its target of 12% to 15% compound returns. It does face a number of risks as it moves forward, but most if not all of its competitors face the same risks (and enjoy some of the same opportunities).

Management

Chief Executive Officer: Bruce Flatt, age 49, took on this role in 2002. He had served in a number Brookfield's investment and operating businesses since 1990.

Independent Chairman of the Board: Frank McKenna, age 67, has held the position since 2010; Mr. McKenna previously served as Premier of the Province of New Brunswick, Canada and in several senior business positions.

Chief Financial Officer: Brian Lawson, who has held senior management positions within Brookfield since the early 1990s.

Board of Directors: 16 members, including ten independents and six affiliated directors.

ISS Governance QuickScore: Not available for this company.

Management and governance profile based on information provided at the company website and reuters.com.

Comments: Both CEO Flatt and CFO Lawson have extensive histories with Brookfield, and Flatt at least is young enough to have more at the helm. And while a large number of company employees serve on the board, there are more independent directors.

Ownership

Gurus: Eight of the gurus watched by GuruFocus hold positions in BAM: Joel Greenblatt (Trades, Portfolio), Ken Fisher (Trades, Portfolio), Lou Simpson (Trades, Portfolio), Ron Baron (Trades, Portfolio), Tom Gayner (Trades, Portfolio), Third Avenue Management (Trades, Portfolio), Murray Stahl (Trades, Portfolio), and Chris Davis (Trades, Portfolio). Lou Simpson (Trades, Portfolio) is the largest holder, with 10,216,317 shares. Murray Stahl (Trades, Portfolio) and Chris Davis (Trades, Portfolio) each own more than 6-million shares.

Institutional Investors: nasdaq.com reports this group of investors owns just over half of the company’s outstanding shares:

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Short Interests: Very low, at 0.15%; even in January 2009, immediately after the financial crisis, short positions stayed below one and a half percent.

Insiders: Insider ownership information is not available from sources.

Comments: Gurus highlight the ownership profile of Brookfield Asset Management, particularly Lou Simpson (Trades, Portfolio) who owns a bit more than 1% of all outstanding shares. Institutional ownership is solid, while short interests are very low.

BAM by the Numbers

Brookfield Asset Management Inc. Â
Number of shares in float 582,770,000
Number of shares outstanding 650,890,000
Price at close, May 28, 2015 $35.90
Capitalization $23,366,951,000
52 week range $28.37 to $39.00
Trailing P/E (ttm) 7.21
Forward P/E (fye Dec 31, 2016) 27.83
Price/Book (mrq) 1.20
Price/Sales (ttm) 1.15
Return on equity (ttm) 11.54%
Dividend in dollars (forward) $0.72
Dividend yield (forward) 1.30%
Payout ratio 12.00%
Share repurchases in fiscal 2014* 8,890,000
Share buyback ratio (fiscal 2014)* 0.01%
Sources: Yahoo! Finance, May 28, 2015, * GuruFocus Â

Also noteworthy: BAM shares split, on a 3:2 basis, on May 13, 2015.

Comments: A $23 billion company with a very low trailing P/E, low P/B, and low P/S. It also provides a modest dividend and share buyback ratio (more on buybacks in the Valuation section).

Financial Strength

The GuruFocus automated system gives Brookfield Asset Management a 6/10 for Financial Strength and an 8/10 for Profitability & Growth:

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Looking for reasons behind the relatively low score for Financial Strength, we’ll start with the Four Severe Warning Signs posted by GuruFocus.

  • Altman Z-Score
  • Piotroski F-Score
  • Long-Term Debt: Keeps issuing new debt
  • Cash Flow: Divergence from reported earnings

Starting with BAM’s Altman Z-Score and Piotroski F-Score, we note that this is to at least some extent a financial company, and as a Wikipedia article notes, “Neither the Altman models nor other balance sheet-based models are recommended for use with financial companies.” So, we will give minimal weight to these two warnings.

Long-term debt: GuruFocus puts Brookfield’s long-term debt at $48,733 billion, as of the end of March, 2015. As the following table shows, that’s an increase from $41.3 billion at the end of fiscal 2012.

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In its Annual Report for 2014, the company justifies that assumption of debt this way, “We have been active in taking advantage of low long-term rates to fix the coupons on floating rate debt and near term maturities. This has resulted in an increase in our current borrowing expense but we believe this will result in lower costs in the long term.”

Free cash flow: the following chart gives us historical perspective on BAM’s FCF:

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Finally, let’s review the company’s earning power, with this chart of EBITDA:

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Comments: We looked at four financial strength concerns. The first two, the Altman Z-Score and the Piotroski F-Score were dismissed as irrelevant; the long-term debt load is significant, but at the same time the company has strategic reasons for taking it on; free cash flow, as the chart showed, has come down lately, and seems somewhat rangebound; and finally, EBITDA is strong and growing.

Valuation

An email message accompanying the May 17, 2015 issue of the Buffett-Munger Newsletter lays out seven criteria for a ‘wonderful’ company, which is to say a company that makes it to GuruFocus’ Buffett-Munger screener:

  1. Simple Business
  2. Favorable Long-Term Prospects
  3. Able and Honest Management
  4. Consistent Earnings
  5. Good Return on Equity
  6. Little Debt
  7. Very Attractive Price

To examine Brookfield Asset Management’s inclusion in the screener’s results, we’ll review two of those criteria: consistent earnings and a very attractive price.

GuruFocus rates most companies it follows with a Predictability rating, Predictability being the equivalent of consistent earnings. Ratings range from 1 out of 5, which is very poor, to 5 out of 5 for very good predictability.

This is one of the best indicators we have for future share price performance, although no guarantee. Backtesting by GuruFocus has found that companies with a higher rating perform better and are less likely to hurt investors.

BAM receives a 4.5-Star rating, a good rating (see the EBITDA chart above). GuruFocus backtesting showed stocks with this rating averaged gains of 10.6% per year, and only 10% of stocks would remain in a loss position if held for ten years.

The other key number we pull from the Buffett Munger screener is the PEPG or PEG ratio. Think of it as a variation on the better-known P/E ratio. We calculate PEG by dividing the P/E ratio (Price over Earnings) by the average EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) growth rate over the past five years.

For Brookfield, that works out to 0.59 (P/E of 11.1 divided by 5-year EBITDA average of 18.7). PEG ratios below 1.0 are considered under-valued; those between 1.0 and 2.0 are considered fair-valued; and those above 2.0 are considered over-valued. Clearly, BAM is under-valued on this basis.

A couple of other notes: First, valuations won’t feel much effect from dividends, which at a forward yield of 1.3% will carry little influence.

Second, share buybacks, like dividends, may have an effect if large enough. But, as noted in the BAM By the Numbers section, the company has not been repurchasing many shares. In its 2014 Annual Report, Brookfield says, “...while we target the repurchase of our own shares, we have not had the opportunity to repurchase significant numbers of shares into the treasury as a result of the stock price appreciating at a compound 21% over the past five years. But as we continue to accumulate cash on our balance sheet, we intend to find opportunities to repurchase shares in meaningful ways when we believe we can do so for value.”

Third, as we noted in the introduction to this article, the April 20 equity offering represented a dilution of roughly 2% in shares outstanding. At that time, the share price was close to $39.00, so a 2% reduction would represent nearly $0.80 of lost intrinsic value. The price gapped down about $1.50, which is more, but not significantly more than the amount of the dilution.

Finally, Brookfield has announced it wants to raise $21 billion this year and early next year to fund new acquisitions, and that suggests further dilution. That $21 billion would follow spending of $15 billion last year. The company says it sees great opportunities in out-of-favor markets and assets burdened with too much financial leverage.

Comments: Brookfield Asset Management earns its place on the Buffett-Munger screener with consistently strong earnings, and serious under-valuation based on the PEG ratio. It is also encouraging to see the company waiting to make stock repurchases at low valuations. However, when we consider the dilution factor, the Buffett-Munger under-valuation seems less apparent.

Conclusion

No doubt the market overreacted somewhat in pulling down the price of Brookfield Asset Management Inc. But, I would argue, not enough to make the company a bargain.

Given this pullback, the company itself might become a buyer of its own shares, but it seems more focused on committing current liquidity to acquisitions.

Given its ambitious plans for acquisitions, we might want to classify this as a growth stock rather than a value stock. No doubt it’s a name well worth consideration by growth investors, but not a short-list stock for value investors.