Brookfield Asset Management (BAM) Reports 2Q12 Results

With headlines; “Brookfield Asset Management Q2 Profit Plunges, Misses View” one would think BAM had a terrible quarter.  Hardly, it was actually a very good quarter for investors.

By nature BAM’s asset management business earnings will fluctuate from quarter to quarter. Profits did fall but temporarily so.  Offsetting these fluctuations BAM  completed a record number of significant acquisitions that will increase intrinsic value in the future. In most cases operations achieved solid performance.

Recall, in our investment thesis estimates the intrinsic value of BAM to increase over 3-5 years to about $38/share in the low case and up to $60-70/share. Management now estimates (2Q12) intrinsic value to be $41.81/share; already above our estimate. Share price eventually catches up to intrinsic value. On the day that these headlines appeared the closing share price was up 0.7% to $34.78 and within $3 of our intrinsic value estimate in just six months.

The two key metrics we need to focus on to measure progress at Brookfield Asset Management is intrinsic value and management’s primary objective of a 12-15%/year targeted total return on equity over the long term. How are they doing on the 12-15%/year targeted total return on equity?  Quite well; in 2011 it was 14% and value creation for shareholders over the long term was:

OK, no complaints there, so let’s look at the quarter with our long term objectives in mind.

Financial Results:

Total return is the amount our key performance indicator, intrinsic value, increases. Total return includes funds from operations (FFO) plus the increase or decrease in the value of our assets over a period of time.

Despite the recent economic volatility:

  1. Total return in 2Q12 for shareholders was $272 million, or $0.43/share
  2. For the first half of 2012 total return was $983 million, or $1.56 per share
  3. Total return includes FFO of $244 million, $61 million of valuation gains; less $33 million preferred share dividends.

Consolidated basis:

  1. FFO totaled $613 million; $244 million (or $0.34 per share) to shareholders; compared to $309 million of FFO for shareholders in 2Q11
  2. FFO reflects improved performance and conditions in most operations; partially offset by below average generation in renewable power (low rainfall) and unfavorable  impact of market volatility on investment securities

Valuation gains include:

  1. Fair value changes recorded in net income and other comprehensive income
  2. Net gains during the quarter reflect continued increases in commercial property valuations
  3. Largely offset by marked to market interest rate hedges used to lock in favorable rates on future debt until the loans are refinanced

The intrinsic value of our common equity was:

  1. $41.81/share at 2Q12 vs. $40.99 at 4Q11; $39.31 at 2Q11; $42.35 at 1Q12
  2. The 2Q12 decline from 1Q12 is due largely to the impact of lower foreign exchange rates

Consolidated net income was:

  1. $379 million; $138 million (or $0.17 per share) accrued to shareholders
  2. Net income includes FFO; non-cash revaluation items such as depreciation and changes in the appraised values of commercial properties vs. $838 million (or $1.26 per share) in 2Q11
  3. 2Q11 is a tough quarter to compare to due to the exceptional increases in U.S. commercial office & retail property valuations

Operations:

Although headline “profits” were down for the quarter the company completed a record number of acquisitions and most operations were solid despite market volatility. BAM and publicly traded units accomplished the following during 2Q12:

  1. Acquired $600 million portfolio of four additional U.S. hydroelectric facilities adding 378 megawatts of generating capacity in the southeastern States;
  2. Began commercial operations at Canada’s largest wind power facility and advance construction on four projects with a further 99 megawatts of installed capacity;
  3. Largely completed a $600 million Australian rail expansion now contributing to FFO, it is two months ahead of schedule, and will be at a minimum run rate of $150 million/year by 1/13;
  4. Brazilian residential businesses completed R$358 million of launches and contract sales of R$737 million;
  5. Acquired a joint controlling interest in a 3,200 kilometer Brazilian toll road company servicing one of the fastest developing economies in the world;
  6. Acquired, with institutional investors, the remaining 45% of the Santiago Chilean toll road network;
  7. Announced the launch of a one million square foot office building in Toronto with a global professional service firm as lead tenant, opened a fully leased office building
    in Perth Australia and leased 2.7 million square feet of commercial office at
    rents substantially higher;
  8. Initial rents for U.S. mall portfolio increased 9.6% higher on a comparable basis from 2011;
  9. Reached an agreement to acquire and recapitalize a U.K. utility business with an
    enterprise value in excess of $1 billion;
  10. Acquired a £518 million portfolio of six office buildings and development sites in London a global financial center;
  11. Acquired over $1.5 billion of office, retail and industrial properties in the U.S. and Australia;
  12. Closed over $3 billion of capital across private funds during the quarter of which $2 billion came from third party investors and seeking an additional $4 billion of third
    party capital;
  13. Issued $0.5 billion of additional equity in infrastructure (BIP);
  14. Continue to advance the launch of the global listed property business (Brookfield Property Partners, BPY) that will rank as one of the largest in the world, estimated to
    occur in 4Q12 with spinoff of 10% to existing BAM shareholders.

I’ll opt for defered gratification and take the long term potential economic gain these projects offer and ignore the temporary quarter to quarter economic blips.

Dividend Declaration:

The Board of Directors declared a quarterly dividend of US$0.14 per share ($0.56/year) payable on November 30, 2012, to shareholders of record on November 1, 2012.

Summary:

Our BAM investment thesis centers on the uncertainty stemming from the worldwide macroeconomic malaise. After a decade of stock market turmoil, investors are fearful of stocks and currently running to “safer” bonds at probably the worst possible time. Interest rates are at lifetime lows and when they go back up, as they eventually will, long term bond prices will drop.  As a result the case for investing in real assets with real returns from stable cash flows with geographic and currency diversification has never been stronger.  BAM provides that to both individual and institutional investors. CEO Bruce Flatt summarized Brookfield’s view quite well in the 2Q12 Letter to Shareholders:

“We are fortunate to have been at the forefront of establishing ourselves as a global manager of real assets and with interest rates at historic lows, we believe real assets will continue to be a compelling alternative for institutional clients looking for superior overall returns. As a result, institutions are now on average allocating 5% – 10% of  their funds to real assets. We expect that over the next 10 years that most institutions will increase their allocations to 25% – 40%, which means many trillions of dollars
of capital allocated to real assets in the coming years.”

“We believe this trend will be similar to the period decades ago, when institutions shifted allocations from bonds to common stocks. As a result, this will have a dramatic global impact, as it did with equities in the past. Major capital shifts can often crowd out good returns. While there is some risk that this will occur within the real asset space, it is important to note that there is a confluence of events occurring. That is,
the supply of assets available for investment is likely to grow dramatically; as governments undertake the major deleveraging that must occur to get their fiscal books in order.”

Perhaps the headlines should read; “Brookfield Asset Management Ignores Q2 Noise, Stays Focused on Long Term Value Creation for Shareholders, Analysts Misses the View”.

For further information:

2Q12 Press Release, Letter to Shareholders, Supplemental, Financials here.

2Q12 Conference Call and Webcast here.

Brookfield Property Partners (BPY) Presentation here.

Disclosures: I am long BIP,BAM,BREP.

The information contained herein is provided for informational purposes only, is  not comprehensive, does not contain important disclosures and risk factors associated with investments, and is subject to change without notice. The author is not responsible for the accuracy, completeness or lack thereof of information, nor has the author verified
information from third parties which may be relied upon. The information does not take into account the particular investment objectives or financial circumstances of any specific person or organization which may view it. Nothing contained within may be considered an offer or a solicitation to purchase or sell any particular financial 
 instrument. Any investment can be very risky and is not suitable for everyone. You should never enter into an investment unless you can afford to lose your entire investment. Always complete your own due diligence. Before making any investment, investors are advised to review such investment thoroughly and carefully with their financial, legal and tax advisors to determine whether it is suitable for them.

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