Profit from the rush into alternative assets with Blackstone and Brookfield (NYSE: BAM)
Blackstone Inc. (NYSE: BX) and Brookfield Asset Management Inc. (NYSE: BAM) are among the best in the global alternative asset management industry, with over $1.5 trillion in assets under management between them.
We believe that alternative assets will experience a protracted boom for the rest of this decade and possibly even beyond due to many macro factors that we will discuss in this article.
Given that the stock prices of BX and BAM have recently experienced steep declines alongside broader market turmoil despite posting strong results, we believe now is the right time to add stocks.
Why we’re bullish on alternative asset managers
The main bearish case on alternative assets right now is for interest rates to rise. Interest rates have risen significantly in recent months and look poised to rise further before falling:
However, zooming out for a historical perspective, we can easily see that interest rates remain at the lower end of the historical spectrum:
Interest rates look even lower relative to the rate of inflation:
This last point is essential, because alternative assets generally benefit from high inflation but are penalized by high interest rates. Therefore, when real interest rates (i.e. the difference between the inflation rate and the nominal interest rate) are negative, this bodes well for alternative assets and when interest rates real interest rates are significantly positive, this may bode ill for alternative assets.
High interest rates hurt alternative assets for the following reasons:
- This makes leverage more expensive and generally harder to obtain. Since investments in alternative assets are generally highly leveraged, this can reduce the cash flow yield as well as the total return potential of these investments.
- It increases the risk-free premium on alternative assets. If an investor can earn a 5% yield on US government bonds, they are much less likely to buy a toll road or a warehouse at a 5% cap rate, since government bonds are generally considered to be far less risky.
Alternatively, high inflation rates favor alternative assets because:
- It drives up the replacement cost of alternative assets, giving them a higher barrier to entry and therefore more pricing power. This in turn pushes the value and cash flow capacity of these assets upwards.
- High inflation is usually a symptom of vigorous economic activity, which means that demand for alternative assets is usually stronger.
The outlook for alternative assets remains very positive. Indeed, the real interest rate is deep in the red right now and is unlikely to turn black anytime soon due to the likelihood of persistently high inflation for the foreseeable future. Combined with the incredibly high US government debt and deficit, this makes raising interest rates too high unsustainable.
Third, there is a large and growing wealth gap between the world’s major economies. In order to combat growing resentment and political and social unrest among the general population of these countries, governments are likely to increasingly look to infrastructure projects to help improve the livelihoods of low-income segments of the society. This has already happened in the world’s two largest economies. China has undertaken massive infrastructure and construction initiatives to support its economic growth, while the United States recently passed a bipartisan infrastructure bill and this effort is expected to continue in the future.
Fourth, as the United States and China increasingly face each other on the world stage and compete in developing countries for geopolitical influence, access to valuable natural resources and base facilities strategic military, these countries are investing more and more in the development of the infrastructures of these other nations. While much of the money for these developments comes from governments, often the execution of these contracts and even the ownership and/or operation of these assets are privatized due to efficiency, capacity and risk mitigation.
These four macro trends point to a solid conclusion: real assets are set to boom in the coming years, with competitively positioned global alternative asset managers like BAM and BX poised to benefit hugely.
As BAM noted on slide 7 of its September 2021 investor presentation, in 2000 institutional investors allocated only 5% of their assets to alternatives. By 2021, that number had risen to 30%. By 2030, this number is expected to have doubled to 60%. With trillions of dollars pouring into space, BAM and BX should have another stellar decade ahead of them.
BX Stock Valuation
In addition to bullish macro trends for the company, BX stock currently looks attractively priced.
The forward P/E ratio is 17.37x, well below its five-year average of 26.51x. The price-to-free cash flow ratio also looks sharply reduced from its five-year average, with the current ratio standing at 8.41x compared to its five-year average of 13.09x. Finally, its forward dividend yield is 4.84%, which looks very attractive compared to its five-year average of 3.27%.
More impressively, analysts predict rapid growth in earnings per share, free cash flow and dividend per share over the next five years, with CAGRs of 12.8%, 27.2% and 11.5% provided for each, respectively.
This strong growth will likely be fueled by continued robust fundraising for its various investment funds, coupled with performance incentive fees on these funds, as BX’s superior investment knowledge, talent asset management and its deal flow combine with the bullish macro picture of alternative assets to continue to be robust. returns for its customers and shareholders.
While real estate and private equity have been BX’s two largest investment sectors, BX is also accelerating its growth in retail and insurance investments, more than doubling the size of its presence in these spaces over the past of the past year.
As long as inflation continues to outpace interest rates – which we believe is very likely in the long term given that this is the only way for the most indebted governments (including the US) to remain solvent – BX’s vast real estate and private equity assets Empires should continue to generate strong returns, which should also drive the stock higher over time.
Valuation of BAM shares
BAM stock also looks attractively priced, although its valuation metrics are a bit different than BX. Based on adjusted funds from operations (i.e. AFFO), BAM looks deeply undervalued as it trades at just 11.03x compared to its five-year average of 15.98x. On a price/FFO basis, BAM is also undervalued, with a current multiple of 15.62x from its five-year average of 17.41x, although analysts expect FFO per share to record. an impressive CAGR of 18% over the next five years.
This growth will be driven by BAM’s many growth initiatives, ranging from its strong Green Energy/ESG (BEP) funds (BEPC), its world-leading infrastructure business (BIP) (BIPC), its growing private equity (BBU) (BBUC), its Oaktree-led credit business (OAK), as well as its new ventures in insurance (BAMR), technology, and attracting investment from small investors in addition to its solid network of institutional investors.
Another way to look at BAM’s valuation is to look at the sum of its parts. Its annualized asset management fee in the first quarter of 2022 was $1.9 billion, while its net carried interest was $2.2 billion. Applying a 20x multiple to asset management fees and a 5x multiple to its carried net interest implies a $49 billion valuation for the asset management business. Meanwhile, the invested capital balance sheet had a net worth of $56.9 billion. In total, that puts the company’s total net worth at $105.9 billion, compared to its current market capitalization of $78.3 billion. This implies an upward valuation of around 35% for the stock.
Key takeaway for investors
The macro outlook for alternative assets is extremely optimistic at the moment, and BX and BAM are exceptionally well positioned to benefit from it. Their formidable track record of generating crushing market returns for clients, their global scale and impressive deal flow combine to give them access to an incredible stream of additional assets to manage. On top of that, their stocks look undervalued at the moment and look set to deliver strong outperformance going forward for investors at current prices.
That said, we believe there is a better opportunity in the alternative asset management space than Patria Investments (PAX), so we personally aren’t long on either name at this time. .