I have been following Brookfield Asset Management (BAM, Financial) for the last three years, and I like their approach of investing in long-lasting real assets with contracted cash flows. With interest rates likely to rise in the long term and higher inflation most probable, I decided to take a closer look at BAM at current valuation to see if it is a good candidate to add to my position.
I) The Record
Brookfield Asset Management (BAM, Financial) has provided a 19% return per year over the last 20 years. This is very impressive performance by any standard. Shares ofBrookfield Asset Management are trading around $35 as of early June 2013. Shares traded at a price of $41 in 2007 and fell to a price of $11 in March 2009 where shares of all real estate related companies were being punished. BAM invested significant capital during the 2009 to 2012 period and has grown the net asset value (NAV) per share from $26.5 in 2008 to $40 by December 2012.
II) Business and History
As per the company website:
“Brookfield is a global alternative asset manager with over $175 billion in assets under management. We have over a 100-year history of owning and operating assets with a focus on property, renewable power, infrastructure and private equity.
On behalf of our clients and shareholders, we own and manage one of the largest portfolios of premier office properties and renewable power generating facilities as well as long-life infrastructure assets that include utilities, transport and energy and timberlands in North and South America, Australasia and Europe.
We invest our own capital alongside our clients and partners in these high quality assets, ensuring our interests are aligned. Our assets are held through a growing portfolio of private funds and public, listed entities. We are proud of our track record for achieving strong risk-adjusted returns for our clients, partners and shareholders across all market conditions.”
III) Operations and Competitive Advantages
Information from the company website about operations is as follows:
“Brookfield operations are categorized in five segments:
Property Overview
Renewable Power & Infrastructure Overview
1. Property
Brookfield Property Group is Brookfield’s most significant investment platform, made up of our sector-specific operating platforms in the office, retail, multi-family, industrial and hotel asset classes. With approximately $103 billion of property assets under management and interests in over 300 million square feet of commercial space globally, we are one of the world’s largest and most sophisticated owners, operators and investors in property. Brookfield has built its property platforms through the integration of formative portfolio acquisitions and single asset transactions over many decades. Our collaborative and disciplined approach to investing has been successful throughout ever-changingmarket cycles. Having invested over $16 billion of equity capital into real estate transactions since 1989, we have a significant track record of delivering strong, risk-adjusted returns to our investors in our many listed company and private partnership vehicles. 
2. Renewable Power
With renewable power assets under management valued at approximately $19 billion in North and South America, Brookfield is one of the largest independent owner-operators of high quality, low cost, renewable, hydroelectric and wind power generating facilities. Backed by 100 years of operating experience, our facilities are environmentally friendly, long-life assets that generate stable, sustainable cash flows, and require minimal ongoing capital expenditures. Recognized for our ability to optimize the value of our portfolio through disciplined management and innovative financing, we continue to expand our operations through acquisitions and new development projects, including a newly constructed wind farm in Northern Ontario, the largest of its kind in Canada.
Today we have 185 hydro and wind generation facilities with approximately 5,300 megawatts of capacity.
3. Infrastructure
Brookfield invests globally in long-life, infrastructure assets that generate stable and growing cash flows with high barriers to entry and low maintenance capital requirements.
Infrastructure is recognized as an important asset class critical to the support sustainable economic development with institutional investors increasingly attracted to this sector, because of its relatively low volatility and solid returns. Brookfield has over 100 years of experience owning and operating infrastructure assets. Our portfolio under management includes direct and indirect ownership interests in utilities, transport, energy and timberlands in North and South America, Europe and Australasia.
(3.1) Utilities
Utilities transmit and distribute essential products and services such as electricity, natural gas and water to communities on a global basis. Brookfield has owned and operated various utilities businesses for over 100 years in both North and South America. Today, our portfolio of utilities under management includes electricity transmission, natural gas transmission, distribution and storage services in North America, Australasia and Europe. As an investment, utilities represent a unique asset class. Due to their natural monopoly status, utilities are highly regulated and produce stable cash flows with inflationary growth. Brookfield’s portfolio also benefits from diversity across regulatory regimes with significant opportunities to invest in system expansions at attractive returns.
(3.2) Energy
Brookfield’s energy business is comprised of systems that provide energy transmission, distribution and storage services. The energy infrastructure portfolio includes high quality assets that generate stable revenues, supported by long-term contracts and customer relationships. Brookfield’s holdings include one of the largest natural gas transmission and pipeline systems in the U.S., unregulated natural gas and liquid propane gas (“LPG”) distribution operations in Australia and the UK, and significant natural gas storage capacity in Alberta and the continental U.S.
(3.3) Transport
Brookfield’s transport assets are essential infrastructure networks that move freight, bulk commodities and passengers. Key attributes of our holdings including high barriers to entry, stable revenues supported by long-term contracts or customer relationships and the ability to benefit from increasing customer demand. Assets in this portfolio include toll roads in South America, ports in Australia and Europe and an Australian railroad.
(3.4) Timberlands
Brookfield has an over 35-year track record of owning and operating timberlands in North and South America that generate strong, sustainable cash flows. Our portfolio of timberlands under management is approximately 2.6 million acres and we have a track record for sustainable management of this resource. We believe that our timberland operations have a number of attractive attributes that position us well for continued strong and growing cash flows:
(3.5) Agrilands
Over three decades, Brookfield has built a agricultural development business in Brazil that now encompasses over 540,000 acres of agrilands. We invest our own capital and that of our investment partners in this sector. Our approach is to acquire cattle ranches and, over time, convert this land to more productive uses, typically soya crops as a first step, then sugar cane. This conversion process has generated significant increases in the value of our holdings, and the business holds great promise, as the industry grows to satisfy rising global demand for food and fuel.
4. Private Equity and Finance
Our experience as private equity investors and providers of bridge financing spans three decades, numerous business cycles and some of the most challenging economic times in recent history. Through more than 100 investments and commitments made and $10 billion deployed, we have established a consistent track record of success partnering with companies in industries where we have operating expertise and experience.
Broad sourcing capability positions us to deploy capital throughout the economic cycle. When speed and certainty of commitment are required, Brookfield’s over $150 billion of assets under management and $50 billion client capital base enable us to underwrite investments and loans of all sizes without syndication.
Our Private Equity and Finance investment professionals are located throughout Canada and the United States, Europe, India, Australia and South America. Our global reach and network enables us to surface high quality investment opportunities and provide our portfolio companies with a full range of resources throughout the course of our involvement.
5. Development & Residential
Brookfield is a major residential property owner and operator, with market leadership in land development and home building in North America and Brazil.
Brookfield creates value by applying decades of experience in residential real estate to the full spectrum of development, including land acquisition, planning, design, construction, sales and customer service.
In North America, we operate as Brookfield Residential Properties Inc. and we are active in eleven principal markets in Canada and the United States, with over 100,000 lots under our control. We are the fifth largest residential real estate company in North America, with five decades of experience in the field. Our focus is on master planned communities, where we purchase and develop land, then either build homes or sell lots to third-party builders.
In South America, we are known as Brookfield Incorporacões, a leading Brazilian-based developer. We provide homes to customers across all income classes, with a focus on the middle-income segment. We serve one of the world’s most vibrant economies, and we are market leaders in the metropolitan regions in the states of São Paulo and Rio de Janeiro, as well as the mid-Western region of Brazil. The areas in which we operate generate 60% of Brazil’s GDP.”
[b]Competitive Advantages:
1. BAM invests in long-life cash-generating assets which increase in value over time due to inflation.The scale of BAM and unique operating model which allows access to significant capital is a major competitive advantage that allows it to acquire these assets.
2. Assets of BAM have major barriers to entry and competitive advantages. These include Infrastructure assets like transmission lines, ports, rail, toll roads, power plants and premium office buildings.
3. BAM is not just an owner but an operator of assets and has significant expertise in this area, which is a major competitive advantage. BAM has been operating renewable power assets for decades.
4. BAM has a long-term focus on value creation, which is a competitive advantage. This allows it to be contrarian and purchase assets that are out of favor.
5. BAM is an owner-operated company with management (present and past) owning 20% of the company. Management has a major portion of their assets in BAM stock, so their interests are aligned with the shareholders.
IV) Balance Sheet and Profitability
Brookfield Asset Management (BAM, Financial) has a reasonably strong balance sheet with up to $10 billion of total liquidity including partner cash and corporate debt of $3.5 billion. BAM has real assets that are long life and generate strong cash flows, and the majority of debt is property-specific and non-recourse.
Also, BAM is taking advantage of the low interest rate environment to lock in long-term fixed mortgages at attractive rates. I expect the company cash flow generation to accelerate in the next two to three years as many of the investments of the last two to three years bear fruit and some of the assets will be harvested to reinvest in higher return and higher growth opportunities. Below is information from the company 2012 annual report, 2013 first quarter report and 2013 company presentations:
[b]V) Management
I like the business philosophy and investment guidelines that guide the actions of BAM management. They are as below (as stated in company 2009 Annual Report). These principles have yielded return of 19% per year over last 20 years for investors an excellent performance in times that included multiple recessions, bubbles and a major financial crisis.
Management of Brookfield(current and past) own 20% of the company and thus management thinks and acts like owners. This is a major advantage for shareholders as historically this has been a good indicator of market outperformance. CEO Bruce Flatt and CFO Brian Lawson are doing an excellent job.
VI) Value and Price
BAM is trading in $34 to $36 range as of the first week of June 2013. The NAV (net asset value) of BAM as of 2012 year-end was in excess of $40. The sum of various parts (including liquid assets) indicates an asset value of at least $37. Brookfield Private Equity business has major global growth opportunities and due to the large scale of the operations, there is a significant organic growth opportunity. Recession in Europe and deleveraging by many companies allows great opportunity for BAM to acquire more assets in Europe and South America at attractive prices when considering the low interest rate environment.
Mritik Capital projects an NAV growth of 9% per year over next three years. This is in line with the NAV growth from $26 to $40 over the last four years. This would mean a NAV of above $50 by 2015. Assets including real estate have been out of favor since the U.S. housing bubble crashed and the financial crisis of 2008 and 2009. Given the high likelihood that real estate and property assets will be a more favorable sector of investors in the next few years it seems probable that BAM will trade close to its NAV by 2015 end. I expect strong cash flow generation to allow EPS to grow at a healthy rate and to be in the range of $4 to $5. There is an opportunity for BAM to return 17% total return per year over next three years which is in line with the return over the last 20 years. The nature of the long life cash producing asset which are indexed to inflation also provides downside protection.
Mritik Capital suggests that investors who have a long investment horizon can invest in BAM at $34 and expect to make a return in excess of 10%. More conservative investors can sell December 2013 $35 puts for a premium in excess of $2.75 for an annual return of 15% if put is not assigned while taking the risk of owning BAM at an attractive price of $32.25.
[b]VII) Catalysts
I see the following catalysts for BAM:
1. An increase in long-term inflation will increase the valuation of BAM’s assets while the inflation indexing of cash flows will guarantee a return above inflation.
2. In 2007 to 2008, when property assets were in favor with investors, BAM was trading at 40% premium to NAV. As the housing recovery takes hold BAM is likely to trade at more favorable valuation.
3. Continued organic growth and intelligent capital allocation by BAM management can significantly grow the intrinsic value of the company and the market will ultimately recognize the value.
4. BAM’s private equity business has opportunity for global expansion. The quantitative easing policies of global central banks will increase liquidity further, and BAM will get its fair share of these investable assets, leading to increased fees. Assets under management (AUM) are currently at $175 billion can increase significantly over the next decade.
5. BAM can harvest some of the investments made at attractive rates from 2008 to 2011 and re-invest them at higher rates of return increasing value.
6. BAM can further spin off assets into subsidiary companies to allow the market to value the assets better and to unlock value. The spin-off of Brookfield Property Partners LP (BPY, Financial) is an example of this.
7. BAM is in the process of a share buyback with approval to purchase more than 53M shares which is about 8% of the shares outstanding. It is highly like that excess cash could be allocated to this buyback in 2013 and this should increase per share intrinsic value.
VIII) Specific Risks
1. BAM takes calculated risks when management feels that the risk adjusted reward is significant. This can be an issue if management makes a mistake.
2. The onset of a global recession would affect commercial property asset values and reduce the operating cash flow of BAM.
3. Unfavorable tax law changes can have an impact on how BAM operates. Some subsidiaries of BAM including BIP operate from Hamilton, Bermuda, and have tax advantages. REIT and Limited Partnership-related tax law changes will impact BAM.
4. BAM has dual voting stock which concentrates control of the company in the hands of a select few. This can be a risk.
IX) Why Is This Cheap?
1. BAM has a complex corporate structure which is a deterrent for many investors and makes valuing the company difficult.
2. The market is more focused on net income and not at the significant NAV. I expect net income to catch up over the next few years as investments over the last few years bear fruit.
3. BAM shares fell from above $40 to $11 during the 2008 to 2009 financial crisis. This high volatility at the time of the crisis dissuades some investors from investing in BAM.
Disclosure
I am long shares of BAM.
Comments and questions welcome.
Read more:
Brookfield Infrastructure Partners
Brookfield Renewable Energy Partners
Note:
I have used information from the BAM investor presentations and financial statements. I have referenced information from RBC Investing and Yahoo Finance.
