3 Reasons Brookfield Asset Management Is One Of The Best Dividend Stocks In The World
Dividend growth investing, REITs, newsletter provider, value
We recently wrote on Blackstone Group and we thought it would be good timing to check under the hood of another leading asset manager, Brookfield Asset Management.
We expect BAM should be able to achieve about 19% CAGR total returns over the next five to 10 years. (Managements valuation estimates put that at about 22% to 26%.).
Brookfield has just barely scratched the surface of several global economic megatrends that combine to create a tremendous growth runway in the coming decades.
This article was co-produced withDividend Sensei.
We recentlywroteonBlackstone Group(BX) and we thought it would be good timing to check under the hood of another leading asset manager,Brookfield Asset Management(BAM).
Our greatest passion is pointing out great dividend-paying companies that investors can trust with their hard-earned money. Our motto is quality first, valuation second, and patience and discipline always.
Thats because history has shown that quality dividend-growth stocks, given enough time, are some of the best ways to exponentially compound both your income and wealth and thus a great way to achieve financial independence.
While there are no truly perfect dividend growth stocks, some do come close, combining world-class management, with highly lucrative and scalable business models that tap into global economic megatrends that create decades-long growth potential for cash flow and dividends.
Brookfield Asset Management is one of our favorite companies in the world because of three factors that should be able to deliver safe and steadily rising income, as well as market-trouncing returns, not just for the next few years but potentially for the next 50+ years.
That means continuing its impressive track record of enriching investors with market-crushing total returns. Since current CEO Bruce Flatt took over the top job in 2002, BAM hasdelivered 19.4% CAGR total returnscompared with the S&P 500s 7.2%. BAM has simply crushed it.
In fact, from todays valuation, we expectBAM should be able to achieve about 19% CAGR total returns over the next five to 10 years.(Managements valuation estimates put that at about 22% to 26%.)
That makes it as close to a perfect buy and hold forever stock as you can find on Wall Street, and for investors comfortable with its risk profile, it is a great potential addition to your diversified income growth portfolio.
Good management is essential because the entire point of passive investing is that companies work hard for you so you dont have to. Well, Brookfields management is arguably the best in the world at hard-asset investing (real estate, infrastructure, utilities, renewable energy).
BAM traces its roots back 117 years, but the modern Bruce Flatt era has seen the asset manager grow to $365 billion in assets under management, including $150 billion in fee-bearing capital. $71 billion of that $150 billion in fee-earning assets is from 630 institutional clients, with $64 billion in its listed LPs, such asBrookfield Renewable Partners L.P.(BEP),Brookfield Infrastructure Partners L.P.(BIP),Brookfield Property Partners, L.P. (BPY), andBrookfield Property REIT Inc.(BPR).
The companys growth has come under the fantastic asset allocation decisions and strategizing of CEO Bruce Flatt, who has been with BAM since 1990 and in the top job since 2002.
Flatt oversees 124 managing partners who make the investing decisions and in turn oversee the more than 80,000 operating employees who run the assets in over 30 countries on five continents.
Brookfield invests in the classic Buffett/Graham style, seeking to buy high-quality, income-producing assets at significant discounts to fair value, when other investors are most fearful.
For example, in 2018 Brookfield invested $5.3 billion into midstream infrastructure to take advantage of the midstream bear market, now in its fifth year.
Over the past 13 years Brookfield has put together more than $27 billion in infrastructure dealsalone, plus tens of billions in profitable acquisitions in real estate, and renewable infrastructure. But unlike all of us, who work hard for our money and then want to leave it up to expert management teams to run our businesses, Brookfield isnt just a passive investor. Its also a world-class operator and investor, improving its assets and then selling them for extraordinary profits.
For example, in infrastructure, BIPs 11 asset sales since its IPO have averaged 25% annualized returns. Those are literally Buffett/Graham-like numbers, highlighting how Brookfield is truly a master of value investing in its niches.
Brookfields investment chops are also evident in looking at its returns in real estate, where its funds consistently deliver returns on par with those of the greatest investors in history.
In fact, across its entire empire of hard assets, BAM has delivered 19% in annualized returns for investors over the past 20 years, crushing the broader market and attracting an ocean of new capital from both retail and institutional investors eager to cash in on numerous megatrends in hard assets.
In order to meet that need BAM has constructed a complex empire, yet has managed it masterfully.
80% of BAMs own capital is invested in its LPs, each of which is designed to pay generous, safe and growing payouts (5% to 9% per year) and which deliver 12% to 15% long-term returns for investors.
The company generated $4.3 billion in operating cash flow over the past 12 months that converted to $2.4 billion in cash available for distribution or reinvestment (11% year-over-year growth). By 2023 Brookfield expects cash flow available for distribution (aka free cash flow) to double to $5 billion.
And over the past year Brookfield was very busy, putting $30.1 billion to work into new investments, ranging from the GGP and Forest City REIT acquisitions to acquiring major stakes in Oaktree Management and an automotive battery maker (similar to Buffetts former investment in Duracell).Over the last two years Brookfield has invested $55 billion into deals in which it took public companies private, showing the kind of financial hammer it has the power to swing.
OK, so maybe Brookfields management is top rate, but great management is just one reason that we consider Brookfield one of the best dividend growth stocks in the world. As important is the companys massive growth runway, created by a business model that is, for all intents and purposes, infinitely scalable.
Like in most businesses, great returns require both a long and large growth runway, and access to sufficient low-cost capital to execute on those opportunities. Well, Brookfield has access to literally an ocean of low-cost liquidity and capital from eager investors, both on the retail and the institutional side.
In just the past year its private equity funds have raised another $22 billion and its vast array of revolving credit facilities give it no less than $36 billion in dry powder available for further investments.
Brookfields fee-bearing capital is invested in a diversified and global mix of real estate, infrastructure, renewable energy projects, and now also fixed-rate bond investments (Oak Tree will add $120 billion to that figure), plus its new securitized-debt-offering business.
The company runs 34 private equity funds and of course its famous LPs, of which Im a big fan of and have about $35,000 invested in myself (via BIP and BPY). I eventually plan to invest in other Brookfield LPs and yieldcos such as BEP and TERP (and of course BAM itself).
Brookfield also owns stakes in three publicly traded US and Canadian companies including:
Norbord: an international producer of wood-based panels of which BAM owns 43%
Acadian: a leading supplier of primary forest products in Eastern Canada and the Northeastern U.S (45% ownership)
Vistra: an integrated power company based in Texas of which BAM owns 9%
The LPs pay Brookfield nearly $1 billion in annual base management fees, plus rapidly growing incentive distribution fees (from those safe payouts growing at 5% to 9%).
And Brookfields legendary dealmaking resulted in $1.3 billion in capital gains (at the corporate level) from opportunistic asset sales ($1.3 per share) over the past 12 months.
The companys organic growth backlog, in which it expands and improves its existing assets (thus making them more valuable) stands at $13.3 billion. For context, if BAM were a midstream MLP, its growth backlog would be the the third largest behindTC Energy(TRP) andEnbridges(ENB).
But the real source of this asset managers rapid long-term cash flow growth is going to come from growing its AUM base. And in that regards BAMs growth runway is impressive indeed.
Retail investors love hard assets, because they represent a source of recurring cash flow supporting safe and steadily growing distributions/dividends. Over the past decade retail investors have poured about $40 trillion into this space, which has benefited Brookfield LP investors immensely.
Similarly, Brookfields institutional client base – which stood at 630 major institutions (like ultra high net worth home offices, pension funds, and sovereign wealth funds) at the end of the first quarter of 2019 – is growing rapidly and on track to nearly double to 1,000 by 2023. Brookfield attracts its institutional investors via partnering with 13 leading global financial advisors and since 2013 its average institutional client account has grown 60% to $230 million.
Management estimates that the institutional asset potential will double from 2017 to 2030, creating a total addressable market size of about $230 trillion. That massive figure, which is roughly 3.5X the size of the global economy, highlights how – despite already managing $365 billion – Brookfield is just barely scratching the surface of its growth potential.
OK, so those are some very exciting big numbers, but what does all this potential growth mean for the bottom line?
Management expects to grow its fee-bearing capital 14% annually via organically attracting new investor capital. (Deals like Oaktree instantly add $120 billion and mean BAM will likely surpass $245 billion in fee bearing capital by the end of 2019.)
More important, the company expects its numerous sources of income to drive 18% fee growth, which should convert to similar growth rates in cash flow. 18% cash flow growth would make Brookfield one of the fastest-growing asset managers (or corporations of any kind) in America. And best of all, it is likely that growth rate will be sustained for much more than five years; it could easily last for the next 50 given the massive need for new infrastructure, renewable energy and real estate in a rapidly growing and urbanizing world.
The first thing we look at when considering any dividend stock is its quality, based on my 11-point, 3-factor quality-scoring system.
BAM is a level 10/11 SWAN stock based on its payout ratio, balance sheet, cash flow stability, ability to invest profitably, business model scalability, managements capital allocation track record and dividend friendliness.
The only reason we dont rate BAM a 5/5 on dividend safety (which would make it a 11/11 Super SWAN) is because the companys priority isnt raising the dividend at a fast rate, but growing its business.
For example, the dividend was frozen from 2008 to 2011, and in recent years (since 2015) has been raised like clockwork at a rate of $0.01 per quarter per year.
Brookfield has compounded its FCF/share at a staggering 31% CAGR over the past decade (and 15% CAGR over the past 20 years, including during two recessions). That slow but steady growth, combined with roughly 7% dividend growth, has resulted in a rock-bottom 11% payout ratio.
In other words, what Brookfield lacks in dividend growth or yield it more than makes up for with safety. While asset management is a highly cyclical and economically sensitive business, BAMs cash flow could crash 80% and its payout ratio would still be 55%, below the 60% level thats considered safe for this industry.
Now we know that some of my readers are subscribers to Simply Safe Dividends (where Dividend Sensei is an analyst) and might worry about the companys 55/100 borderline safe dividends.
Its important to point out that SSDs dividend safety model is meant to be extremely conservative (its predicted 98% of dividend cuts since its 2015 founding). And SSD defines borderline to mean as safe as the average corporation because it assumes that subscribers are extra conservative and thus want to only own above-average-safety companies.
SSDs algorithm, which is constantly being tweaked and improved, gives a lot of weight to long dividend growth streaks, and the balance sheet (as does ours).
That explains why the model assigns BAM a lower safety rating: Brookfields leverage and interest coverage metrics are far from safe levels for most companies.
But its important to remember that Brookfield (and its LPs, like BIP, BEP, BPY/BPR) are famous for their safe use of non-recourse, self-amortizing debt (held by over 500 individual assets).
As a large owner of so many of its LPs (which essentially use corporate mortgages to buy their undervalued income producing assets that service the debt used to purchase them), BAMs consolidated debt appears far bigger than it actually is.
Heres Bruce Flatt explaining how Brookfield uses its non-recourse debt
We operate with debt on an asset level basis in order to reduce risk and maximize return on capital. The benefits of asset level debt, versus corporate level debt, have proven to be significant over many decades…Each financing is recourse only to the asset it finances, with no recourse to anything else. As a result, our leverage is extremely low risk and has stood the test of time over the past 30 years including during periods of stress…
As an example, the Clarios financing mentioned earlier is recourse only to Clarios. It is not recourse to Brookfield Asset Management, Brookfield Business Partners, or our Private Equity fund; nor is it cross-collateralized to anything. It stands alone, like virtually all of our financings. For accounting purposes, however, we are obliged to show this non-recourse asset level debt on our Brookfield Asset Management consolidated balance sheet. This is required because we are the manager of the fund that acquired the company, but it is not corporate debt.
Corporate debt, which investors are actually responsible for, is just $7.5 billion or 6% of its total (long-term fixed rate with average duration of 10 years with average interest rate of 4.6%). Its corporate debt/EBITDA ratio is 0.5, and its corporate interest coverage ratio is 10.4. That explains why BAM has an A- credit rating from S&P and a BBB equivalent (positive upgrade for possible upgrade) from Moodys.
Moodys really likes Brookfields $4.7 billion acquisition of Oaktree Capital (OAK), whichmakes one of the worlds best dividend stocks even better. Specifically, Moodys considers the deal a highly credit positive move, saying,
The review of Brookfields ratings reflects the positive effects the Oaktree acquisition is expected to have on the companys credit profile, including diversification into new alternative asset classes, increased scale of revenues and assets under management, and the synergistic benefits of affiliating with one of the leading fixed income managers in the world…
Oaktrees $120 billion of assets under management will augment Brookfields $355 billion, resulting in a firm with one of the largest combined asset bases of alternative products in the world. Both firms are known as value investors in their respective asset classes.
But the bottom line is that Brookfields balance sheet, and thus its dividend, is far safer than it initially appears. Given the conservative nature of bond investors (primarily focused on capital preservative and risk management), if the bond market and credit-rating agencies arent worried about BAMs debt, we dont think retail investors should be either.
And then theres Brookfields long-term total return potential, which is the biggest reason to own the company.
Dividend Yield Theory Estimated Fair Value: $44.44
Morningstars DCF based fair value estimate (quantitative model): $50.13
Current Price: $47.34 (approximately fair value)
Valuation-Adjusted Total Return Potential: 19.4%
Brookfield expects its fee revenue and cash flow to grow about 18% annually over the coming five years. Since cash flow is ultimately what a stock price is based on, this is a good proxy for price appreciation, assuming management can deliver on its guidance (they have a great track record of that).
So while 1.4% yield is paltry, even by the standards of the broader market, Brookfields total return potential, even at its current fair value price, is still about 19.4% CAGR over the next five years. With return potential like that, this high-quality blue-chip still qualifies as a buy on my valuation scale.
Brookfields own estimate of its intrinsic value is $64, a figure thats been growing 16.5% CAGR since 2015. While all such management estimates must always be approached skeptically, given Brookfields proven ability to value assets correctly over time,we consider $64 to be a realistic upper range of the companys fair value.
If Brookfield is right then its actually 27% undervalued (35% upside) meaning that shares might outpace cash flow growth by 3.1% to 6.2% CAGR over the next five to 10 years. That would bump BAMs total return potential over this time period to 22.5% to 25.6%.
Note that managements long-term return estimate of 24% CAGR closely matches ours. Thats because weve modeled our long-term valuation-total return model on the one Brookfield (and NextEra Energy) use.
Thats literally private equity/venture capital like target returns and on par with the greatest value investors in history.
Benjamin Graham (20% CAGR total returns from 1934 to 1956 vs. 12% for S&P 500)
Peter Lynch (29% CAGR total returns from 1977 to 1990)
Warren Buffett (20.5% CAGR total returns at Berkshire over 54 years)
But regardless of whether you believe managements fair value estimates, or use our own more conservative estimate, the point isBAM is a SWAN stock with one of the highest long-term return potentials on Wall Street.
Thats why we consider it a good buy today for any investor comfortable with its risk profile.
Risk management and proper portfolio construction (asset allocation) is far more important to long-term investing success than actual stock picking. A 1986 study found that 93.6% of volatility (the thing so many investors fear) is determined by asset allocation, or the mix of stocks/bonds/cash you own.
There is no sugarcoating it: BAM is a volatile stock, historically about 31% more so than the S&P 500. Thats due to the cyclical and economically sensitive nature of the asset-management business model.
While there is no denying Brookfields long-term wealth-compounding prowess, those Buffett/Graham/Lynch-like returns come at that expense of gut-wrenching volatility, including a 67.2% peak decline during the Great Recession.
The good news is that the Financial Crisis was a historical anomaly thats not likely to be repeated. Thats because today there are no likely catalysts for another economic meltdown. You can see this by looking at corporate bond credit spreads (yields minus risk-free Treasury yields, i.e., risk premia).
As you can see, during the financial crisis BBB credit spreads exploded due to bond investor fears of sky-high defaults. Even BBB-rated corporations had to pay near double-digit yields to sell new bonds, but today spreads show no indication that the credit market is fearful of a repeat of the Great Recession.
We can confirm this by looking at the St. Louis Feds Financial Stress index, where 0 is the average financial stress since 1993. During recessions financial stress rises to about 1, but since 2011 its been negative – and even during Decembers recession scare, it never came close to the zero neutral level.
Thats not to say that financial stress might not increase quickly, especially if Americas gridlocked government fails to raise the debt ceiling in October.
Since the debt ceiling returned in March 2019 (it was suspended for the 12 months before that due to the latest budget deal Congress made) the US has been above its $22 trillion debt limit. This has forced the Treasury Department to use extraordinary measures to keep paying the governments bills on time.
While there has thus far been no indication that Congress (who must pass a bill raising the ceiling) or the president (who must sign it) are going to play chicken with the solvency of the national government, investors cant exclude the possibility of a major mistake.
Moodys latest estimate is that, should nothing be done by Oct. 8th, the US will start defaulting on its debt on Oct. 9, triggering a potentially catastrophic credit crisis that could match or even exceed the 2007-2009 subprime fiasco (depending on how long it lasts).
But thats a low-probability, long-tail risk, and not necessarily what you should use in terms of making the most of your investing decisions. A potential 2020 recession is more of a concern.A recent Duke University survey of corporate CFOs found that 69% of them expect a recession to begin by the end of 2020.These are the people guiding CEOs in their investment/hiring decisions, so this bodes rather poorly for the short- to medium-term growth rate of the US economy.
But theres good and bad news on the recession-watch front. The bad news is that the 10y-3m yield curve, the best leading indicator of recessions (according to studies by the San Franciso and Cleveland Federal Reserves) has inverted for a third time. Its now on day 15 of its most recent inversion.