Brookfield Asset Management (BAM) has a lot of moving parts in its operations so I’ll briefly highlight key financial results and follow with my thoughts on the investment going forward. I highly encourage readers to review BAM’s earnings release at their website:
- In a difficult year, Brookfield Asset Mgmt generated $1.4B in free cash flow (FCF), well within my target range of $1B – $1.5B. While 2008 was punk pretty much all year, the economic downturn drastically accelerated in the fourth quarer after the demise of Lehman Brothers so examining Q4 2008 results may give us some indication of how BAM will perform in this constrained environment. FCF for Q4 came in at $247M. Excluding one-time gains, BAM generated $241M in FCF.
- As discussed previously, BAM’s balance sheet is hugely misleading due to two major factors: 1) debt is presented on a consolidated basis even for assets with minority interests and 2) many assets are carried below fair value. I refer readers to CEO Bruce Flatt’s letter and the supplemental report (see earnings release) for thorough discussion of their balance sheet intricacies. The main takeaways regarding the balance sheet are roughly $3B in liquidity available for investments/debt reduction and no anticipated issues in refinancing any properties or meeting future debt maturities. The earliest corporate debt due is $200M in late 2010. I do have some concern regarding de facto debt-for-equity swaps in some of the hard-hit subsidiaries (Brookfield Homes [BHS] and Norbord) but management thinks these companies will do well once the economy recovers.
My approach to investing focuses on examining a handful of the key issues that will determine the success of the company and the stock, almost like a variation on the 20/80 rule (20% of people generate 80% of results). Anything more is subject to diminishing returns. With BAM, I focus on 4 key factors:
- Cash flow generation.
- General operations status.
- Access to capital markets and rollover financing.
- Commerical properties market outlook.
Taking Q4′s FCF run-rate on an annualized basis gives us roughly $1B FCF before one-time gains, assuming the credit crisis makes asset dispositions impossible due to credit market constraints or unattractive due to low valuations. Of course, we must examine the prospects for BAM to maintain this level of operations. While some parts of the Brookfield empire are struggling (development and specialty funds), 56% of Brookfield’s Q4 gross operating income was generated by commercial properties and power generation. This excerpt from Flatt’s Q4 letter suggests these segments are well-positioned to hold up despite the global recession:
Commercial Office Properties
- Average occupancy today – 97%
- Average annual lease rollover over next three years – 4%
- Average lease duration – over 7 years
- Average tenant quality – “A” rated
- Average net rent – 30% below current market
- Average financing ratio on asset values – 50%
- Average duration of financing – 7 years
Renewable Power Generation
- Average life of contracts – 12 years
- Average contract prices – nearly 90% are below the level required to support new capacity
- Average term of financing – 12 years
- Average financing ratio on asset values – 40%
- Average emissions of CO2 – virtually nil
- Diversity of facilities – 162 hydroelectric generating plants on 64 river systems
- Ability to store water – equivalent to 22% of average annual generation output
For leveraged concerns, financing may be the most important factor in today’s credit-constrained markets. BAM’s access to capital markets seems relatively healthy compared to other asset managers. Debt at the corporate level is $2.3B with a favorable maturity schedule noted above. Much of the debt on the balance sheet resides in non-recourse mortgages on commercial properties and power generation assets. These assets are appropriately financed to match their contracted cash flows but even should problems arise, the financing is structured such that a default on one property won’t trigger cross-defaults (contrast that to current problems at General Growth Properties [GGP]).
Finallly, every management team gives lip service to creating shareholder value but most companies aren’t buying back shares with stock prices lingering at decade lows. BAM’s management team refrained from wasting capital on overpriced shares and now are buying back shares and maintaining dividend payouts. With solid performance in tough times and an executive team clearly focused on shareholder value (management is required to buy sizable stakes), I consider BAM a core holding in my portfolio. I opened the position at $26 and doubled down at $15. With the current bear market, I’m eyeing the $10 level to add to the position.
- Cash flow targets of ~$1B – $1.5B.
- Increase asset management business relative to operations.
- Maintain dividend as economic crisis plays out.
- Shrinking share count.