Brookfield Stock: Still At NAV Discount Despite 26% Gain (NYSE:BN)

Brookfield Corporation (NYSE:BN)(TSX:BN:CA) is considered one of the most “complex” financial companies in the world. It consists of a holding company, on top of several wholly-owned subsidiaries, and some partially owned subsidiaries, one of which operates the company’s funds. It’s a confusing structure that has led some to feel mistrust of the company and its CEO, Bruce Flatt. Back when Brookfield was known as “Brookfield Asset Management,” the Foundation for Financial Journalism accused the company of having a “pyramid” structure, of the sort that Ben Graham famously criticized in The Intelligent Investor.

I touched on the topic of Brookfield’s alleged accounting misdeeds in some of my own articles.

The conclusion I arrived at was that Brookfield was not as “complex” as it looked, and was not committing accounting fraud. At the top of Brookfield’s corporate structure is Brookfield Corp, below that is several wholly-owned subsidiaries, stakes in Brookfield partnerships, and a 75% stake in Brookfield Asset Management (BAM)(BAM:CA). Below the partnerships are several funds and REITs. Thus there are only three levels of bureaucracy here.

Nevertheless, Brookfield’s accounting can be complex, and this does mean that analyzing the company takes more time than analyzing other companies does. Indeed, after discussing Brookfield with other investors on X (the social media platform formerly known as Twitter), I found that “too complex” was a pretty common complaint for people to make about the company.

As I stated previously, I do not find Brookfield’s structure that complex in itself. Nevertheless, it does take some time to research the company before you understand which Brookfield entity owns which. With this fact in mind, in this article, I will focus on BN, its structure, and its subsidiaries.

When I last wrote about Brookfield on Seeking Alpha, I covered the company’s Q3 earnings release, and said that its stock was a strong buy. Since then, the stock has rallied 26.3% and delivered a 26.56% total return (these figures are accurate as of market close Tuesday). Today, I’m still as bullish on the company as ever-however, I’m downgrading my stock rating to ‘buy’ because of the extremely rapid gain in the stock price since my last article. This rating downgrade in no way means that I’m getting less bullish on the company, just that the gains observed since my last article demand a re-rate of the stock. In this article I will go over the factors that contribute to my bullishness on Brookfield, as well as some potential causes for concern. First, though, let’s address that complexity.

Brookfield: Not as Complex as it Looks

A consistent aspect of bearish takes on Brookfield is the claim that the company is too complex to be worth the trouble.

There is some merit to this point. Although the structure itself isn’t that complex, the fact that some subsidiaries are majority owned and others minority owned creates perceived complexity. When Brookfield owns more than 50% of a partnership, it accounts for that company by the “full consolidation” method, wherein subsidiaries are accounted for first as if they were 100% owned, then later less the portion owned by partners, called “non-controlling interests.” Brookfield has several subsidiaries that are accounted for this way (e.g. Oaktree). It also has some subsidiaries accounted for by the equity method, in which a percentage of the subsidiary’s earnings (less dividends) show’s up in the parent’s financial statements, but never the whole-company totals.

Brookfield’s differing accounting treatments of subsidiaries makes it difficult to wrap your head around the company’s structure-particularly if you are using the company’s financial statements to piece things together. Once you have grasped the company’s financials, however, it becomes clear that it basically has a three level corporate structure, differing from other companies only in how it lets the public invest in some of its subsidiaries.

Brookfield’s Main Businesses

Apart from Brookfield Asset Management-which I’ll address in its own dedicated article-Brookfield has 3 main operating businesses:

• Brookfield Property Group.

• Brookfield Insurance Solutions.

• Oaktree Capital.

In addition, there is BAM and the listed Partnerships, which I’m giving their own dedicated articles. To summarize those opportunities briefly here: both BAM and the B-partnerships are poised well to capitalize on the trend toward increasing investment in alternative assets. PwC sees investment in alternatives growing to $21 trillion by 2025–doubling from today’s level. The fact that the SPY is today at a 24 P/E ratio and the QQQ at a frothy 36 P/E ratio lends credence to PwC’s forecast. If investors don’t want to pay high multiples for stocks at all-time highs, they’ll need to invest somewhere other than U.S. equities, and alternative assets (along with private equity) are the go-to “alternatives” to stocks. BAM manages alternative asset funds while the partnerships invest in them, so both of these Brookfield entities are well positioned.

Now, onto Brookfield Property Group.

Brookfield Property Group both invests in real estate directly and owns a stake in Brookfield Property Partners. These companies invest in prestigious “trophy properties” that lease to “blue chip” companies and wealthy people. Despite rising interest rates, rent ticked upward in 2023. House prices dropped 0.2% in January while office building prices fell 26% in the full year 2023. The price trends themselves aren’t good, but note that core PCE inflation fell to 2.9% in December. Core PCE inflation is the Fed’s preferred inflation measure, and this decline takes us just 0.9% away from Powell’s 2% target. This is all consistent with the Fed’s forecast that rates would come down .75% in 2024. Should that scenario come to pass, it will reduce mortgage financing costs, and likely cause a rise in housing & office building prices. That would be bullish for BN’s real estate fair values.

Next up, we have Brookfield insurance. This is Brookfield’s fastest grower, with distributable earnings up 280% and net income up 1,340% in the most recent quarter. Insurance premiums are rising in the U.S., which would indicate that Brookfield’s insurance revenue should rise this year. At the same time, Fitch sees claims cost moderating. If the current trend in premiums persists and Fitch’s forecast about claims proves correct, then we should see overall insurance industry profits grow in 2024. I expect Brookfield to do at least as well as the industry averages.

Last up, we have Oaktree Capital. It’s an asset manager headed by the legendary Howard Marks. Brookfield owns 67% of the company. Oaktree’s Strategic Credit Fund is up 12.19% year-to-date vs. just 3.84% for the S&P 500. Should the outperformance continue, the fund will likely see inflows, which will drive earnings growth at both Oaktree and Brookfield. There is a good chance of that happening, as Oaktree’s Marks has a 19% CAGR career track record.

Valuation

Having looked at Brookfield’s two wholly-owned subsidiaries and Oaktree, we can now turn to the company’s valuation.

Before getting into the multiples, let’s briefly look at Brookfield’s growth rates in the trailing five year period. This helps put the multiples in context, as higher growth merits higher multiples.

According to Seeking Alpha Quant, BN’s growth rates in revenue, earnings, assets and free cash flow are:

• Revenue: 12%

• EPS: -21%.

• Assets: 15%.

• Free cash flow: 15.6%.

The decline in earnings per share may look alarming, but remember that Brookfield spun off 25% of BAM a year before the Q3 earnings release. It’s expected that GAAP earnings would decline, the high growth in assets and free cash flows are impressive.

Now for the multiples:

• Price/distributable earnings (“DE”): 14 (calculated as $40.96/$2.91).

• Price/sales: 0.66.

• Price/book: 1.6.

• Price/operating cash flow: eight.

Not bad. Now, if we make the adjustment from operating cash flow to free cash flow, we end up with an extremely high (163) price/FCF ratio. However, Brookfield is in the midst of an acquisition spree, hoping to capitalize on the lower asset prices that emerged following the Federal Reserve’s 2022 rate-hiking spree. Going by the company’s historical track record, these deals are likely to work out. So, I’d go with price/DE instead of price/FCF as the cash flow multiple of choice. That one is only 14, which is pretty low. Also, if you discount Brookfield’s $2.91 in TTM distributable earnings, assume 0% growth, and discount the DE at the 10 year treasury yield plus a 2% risk premium, you get a $48.5 price target or 18.4% upside.

None of this is the most bullish thing about Brookfield’s valuation, though. Rather, it’s the discount to net asset value. BN stock owns stakes in Brookfield partnerships that, when added to cash, accumulated carried interest and other investments, are worth $67 billion. Subtract the company’s debt and you’re at $51.4B in NAV. Add the market value of BN’s Brookfield Asset Management stake (three times $16 billion, or $48 billion), and you have $99.4B in total NAV. The current market cap-$63.84B-is at a 35% discount to this amount. So if Brookfield and its supporters are right in using NAV instead of book value for the asset-based valuation, BN has the equivalent of a 0.65 “price/book ratio.”

A word on debt: the reason you might notice that I used “$11.4 billion” as the debt figure for BN when Seeking Alpha Quant has $224 billion on file. The reason for this is I’m working with corporate-level debt. The bulk of the $224 billion in total debt is held at BN partnerships and funds. Given that these entities cannot affect Brookfield’s corporate solvency, the write down to $11.4 billion in debt is justifiable. However, should any Brookfield partnership prove unable to service its debt, it might have to start selling assets to pay off creditors, thus reducing its NAV and ultimately the NAV I have calculated for BN. That’s a risk for investors to watch out for.

The Bottom Line

The bottom line on Brookfield is it’s a growing company whose shares are trading at a significant discount to NAV. Based on assets alone, it should rise in price. The earnings picture is more complex. A rise in interest rates would take a bite out of BN’s GAAP earnings, like it did in 2023. But today, with core PCE inflation trending downward, we have good reason to hope that the Fed will start cutting this year. On the whole, Brookfield is a very exciting value opportunity. I’m happy to be long this stock, as well as Brookfield Asset Management.