Patria Stock: High-Yield, High-Growth, Strong Track Record (NASDAQ:PAX)

Investment Thesis

Patria Investments (NASDAQ:PAX) is successfully executing an ambitious consolidation strategy of the Latin American alternative asset management landscape, delivering economies of scale through sustained AUM growth. Its recurring revenue base is set to be bolstered by significant performance fees as the capital markets’ environment recovers, driving material EPS expansion. At an attractive dividend yield of c.7%, we believe that the company’s earnings are being attributed a higher risk profile than they merit. We see significant capital appreciation upside through dividend yield convergence to its mature peers.

Attractive Business Model

Patria Investments is a leading Brazilian asset management firm with a significant presence in the investment industry, particularly known for its expertise in private equity. Founded in 1988, the firm has expanded its services over the years to include not only private equity but also infrastructure, real estate, credit, and public equities. Patria operates with a focus on the Latin American market.

In terms of investment philosophy, Patria Investments focuses on long-term value creation, working closely with portfolio companies to implement growth initiatives, operational improvements, and governance best practices. This approach has helped Patria build a robust portfolio of investments across different industries, including but not limited to infrastructure, healthcare, education, and technology. The firm focuses on investments in resilient sectors which tend to perform well regardless of the macroeconomic environment – we view this as an important differentiator vs. certain peers who have higher exposure to public markets, growth equity and other higher-risk asset classes.

Patria Investments benefits from what we view as a very attractive and resilient business model, characterized by a stable revenue stream generated through recurring management fees on its substantial assets under management (AUM), which stood at $31.8 billion as of Q4 2023. This solid revenue base is amplified by the potential for substantial upside through performance fees, which can dramatically boost profitability during periods of strong investment performance – in Q4, performance fees accounted for 37% of total revenue.

Patria’s dominant position in the fast-growing Latin American alternative investment market, where it is ranked as one of the leading firms, is another key factor in its equity story. This strategic focus on Latin America allows it to ride the secular regional growth dynamics driven by favourable demographic trends and an increasing demand for infrastructure and private capital solutions. The firm’s extensive experience, deep market knowledge, and proven track record in navigating the complexities of local markets are key differentiators that underpin the investment thesis​​.

Sustained Growth In Assets Under Management

Patria Investments has demonstrated a sustainable and steady growth in its AUM through a combination of strategic acquisitions, organic inflows, and positive valuation impacts. The company’s total AUM increased to $31.8 billion as of Q4 2023, marking a 17% rise from $27.2 billion a year earlier. This growth over the past year was driven by $4.6 billion in capital inflows and further bolstered by a $3.1 billion positive impact from valuations and currency fluctuations, although this was partially offset by outflows of $4.6 billion. The “net organic” AUM flow for FY2023 was negative by $30 million, reflecting a widespread more challenging environment for capital raising in the industry, but we take comfort from the Q4 figures which show a net organic inflow of $270 million, suggesting a reversal of the first 9 months’ trend. In the coming quarters, we expect a consistent net organic flow as capital markets conditions improve, driving steady growth in Patria’s management fees.

Patria Investments’ distribution platform and strategy play a crucial role in driving this consistent AUM growth by effectively reaching and engaging with a broad and diverse investor base. The company’s global presence, highlighted by its operations outside Latin America, accounting for approximately 84% of its client AUM distribution, showcases its ability to attract and retain investors worldwide. We see this geographic diversification in LPs as an extremely important hedge against local political and economic volatility.

In addition to launching new funds, Patria has a proven track record in executing synergistic acquisitions. Most recently, in December 2023, Patria announced its acquisition of Credit Suisse’s Real Estate business in Brazil, a move set to significantly bolster its Real Estate vertical with an additional $2.4 billion in AUM. We note that upon closing in 2024, this will result in a c.70% jump from the company’s current real estate AUM, a major step-up. The Credit Suisse deal follows Patria’s acquisition of 50% of VBI in 2022 (one of the largest real estate asset managers in Brazil) and a joint venture with Bancolombia (setting up a $1 billion permanent capital real estate investment vehicle) in July 2023, marking significant steps in scaling its real estate platform across the region. Combined, these acquisitions position Patria to manage one of the largest and most diversified portfolios in the Brazilian market and Latin America more broadly. Asset management is all about economies of scale, so we see these developments as extremely positive tailwinds for future profitability. Additionally, the increasing weight of real estate in Patria’s asset mix further de-risks what we view as an already fairly stable business model.

Recent Decline In Performance Fees

Patria Investments reached its all-time high EPS as a listed company in Q2 2021 ($0.55) but experienced a significant decline since then, primarily due to disappointing performance fees. The average quarterly EPS since then has been $0.17, 70% below the peak. This shortfall in performance fees can be attributed primarily to an unfavourable macroeconomic environment that resulted in limited exits and write-downs in funds’ underlying assets. However, in Q4 2023, the company saw a meaningful recovery in its variable fees: incentive fees of $3.9 million from $0.0 million in the previous quarter, and more importantly, realized performance fees of $40.6 million from $0.3 million in the previous quarter. Combined with a meaningful uplift in FRE margin of 11p YoY to 69%, earnings per share bounced back to $0.47 – just 15% off the peak.

We believe performance fees are set to remain strong in the next 12 months. The World Bank projects a recovery in Latin America & Caribbean GDP growth to 2.5% in 2025, as central banks start to ease monetary policies throughout 2024. Brazilian business confidence in particular seems to have bottomed out and showed signs of improvement in January 2024.

Additionally, the Bovespa index has shown a very healthy performance recently, up 16% in the last twelve months. While completely different business models, it’s supportive to see systemic Brazilian banks’ performing well: Banco do Brasil was up 38% during this period, and Itaú up 28%. We are not concerned by lacklustre performances from Santander, which was affected by a one-off major loss in the wholesale segment triggering an earnings miss, and Bradesco, which is undergoing a restructuring process. In our view, the general capital markets environment is improving, and this is likely to lead to a rebound in Patria’s performance fees through a higher number of investment exits and a write-up of fund assets’ valuations​​ in the next fiscal year.

Compelling Entry Price Point

Patria Investments Limited offers an attractive dividend yield, currently around 7%, which stands higher than many of its asset management peers. In fact, as shown in the chart below, Patria offers a rare combination of high revenue growth and a high dividend yield. Excluding Vinci (VINP), there is a strong inverse correlation between revenue growth and dividend yields, with an R2 north of 50%, as the market rewards high-growth names with higher valuations, driving lower yields.

At the moment, we believe that Patria is being priced as a high-risk leveraged play on the Latin American economy, and not being given full credit for its stable management fees, global LP diversification, strategic focus on resilient sectors, and proven track record of AUM expansion. Over time, we would expect Patria’s dividend yield to contract to the 2-4% range, converging with its more mature, developed-market peers.

In December 2023, management confirmed their intention to maintain the 85% pay-out ratio on the Fee Related Earnings component of Distributable Earnings, which we believe is credible guidance. Based on the company’s target of delivering at least $200 million in Fee Related Earnings in 2025, this would imply a $170 million total dividend payment, or $1.13 per share based on the company’s 150,133,915 total shares outstanding. Conservatively assuming a 5% dividend yield in 2025 would value each share in Patria at $22.6 – a 58% increase from the current level of $14.32.

The valuation upside is also supported by the company’s relatively low P/E ratio of 12.7x. While slightly above local peer Vinci (10.3x), Patria trades significantly below the current average of key asset management peers at 20.0x. We expect to also see partial convergence of this metric over time as the company becoming an increasingly global player and less exposed to local volatility.

Key Risk Factors

The local macroeconomic environment and interest rates pose a risk to Patria’s operations, as fluctuations can impact investment valuations and returns. However, the global macro environment and interest rates are generally improving, which we believe mitigates some of the volatility in local markets and supports the performance of Patria’s investments. The company’s increasingly diversified asset base and distribution network also offer some insulation from any unfavourable local developments.

Brazil’s political landscape inherently introduces some degree of risk, particularly with the potential for policy changes that could affect the investment climate with the current Workers’ Party in power. Yet, with two years until the next major elections, we consider immediate political risk fairly low, providing a stable short-term environment for Patria’s operations.

Investment execution and management are evidently critical risks for any private equity firm, including Patria. However, we take comfort in the company’s demonstrated ability to effectively select, manage, and exit investments. Patria’s strong historical track record of delivering above-benchmark returns clearly showcases its ability to manage these risks and continue generating value for its investors.

Conclusion

We conclude that Patria Investments is positioned for substantial revenue growth and a corresponding increase in earnings per share, driven at the very least by its anticipated continued growth in assets under management. Furthermore, the macroeconomic and capital markets environment in Latin America, showing signs of improvement, is poised to bolster Patria’s performance fees through write-ups and exits within its funds’ portfolios. The strong recovery in performance fees in Q4 2023, having reached rock-bottom in Q3 2023, was a critical positive signal to recover market confidence.

Most importantly, we view an increase in equity value via a reduction in the P/E and dividend yield discount compared to peers as extremely likely for Patria in the short- to medium-term. This adjustment is to be expected with the market’s growing recognition of the company’s robust fundamentals and its dominant strategic position within Latin American alternative investment managers. Lastly, we believe that Patria’s dividend policy is likely to remain stable, offering investors a degree of downside protection even amidst market volatility.

Our recommendation is a firm Buy.