A big reason Brookfield Asset Management is poised to beat high inflation


Same Brookfield Asset Management (BAM 1.13%) has not escaped poor investor sentiment in this current bear market. Therefore, Brookfield’s stock is now down nearly 30% from its all-time closing high. Most people believe that the cause of the current market downturn is the biggest rise in inflation in 30 years.

However, here is one of the main reasons why inflation will help Brookfield outperform.

Image source: Getty Images.

Inflation improves the value of real assets

Brookfield CEO Bruce Flatt has often said that real asset firms are the best places to invest in a high inflation environment. For those unaware, real assets refer to physical or tangible assets – some examples are natural resources, real estate, commodities, and infrastructure such as power transmission lines.

Flatt is bullish on real assets for good reason.

Numerous studies have examined the performance of real assets in inflationary and non-inflationary environments. For example, a Bloomberg study conducted between 2003 and 2020 showed that in times of higher-than-expected inflation, diversified tangible assets, infrastructure, energy infrastructure, and natural resource stocks all had annual returns above the average relative to equities or fixed income securities. . Moreover, real assets also perform relatively well in lower than expected inflation environments. As a result, most of Brookfield’s holdings are made up of real-asset investments, and many people consider it to be the largest portfolio of inflation-protected businesses in the world.

Most of Brookfield’s portfolio requires significant up-front funding, earns very high margins, and has expenses below its cost of capital. Therefore, in an inflationary environment, expenses for Brookfield’s real estate asset business will grow at a fraction of the rate of revenue growth, leading to higher margins and increased investment value. And the rise in Brookfield’s net profit is a sign that the gains from inflation are already showing.

BAM Net Income Chart (Quarterly)
Data by YCharts.

The chart above shows both the negative impact on Brookfield’s net income from the COVID-19-induced economic slowdown and the rebound in net income after the economy began to recover and people started notice a rise in inflation.

The best part is that at the end of 2020, the company had already predicted that in 2021 inflation would skyrocket higher than many analysts had expected, and so it loaded a lot of asset business. real estate, mainly in real estate and infrastructure. Thus, Brookfield investors can expect even higher future returns if inflation persists.

The danger of raising interest rates too high

Rising interest rates are one of Brookfield’s most significant risks, as the company relies heavily on debt to conduct its business. And rising interest rates can significantly hurt highly leveraged companies.

Brookfield’s first quarter 2022 earnings release shows the company has just $11.82 billion in cash and cash equivalents versus $185.03 billion in debt. The stock could drop significantly from current prices if multiple loans default due to runaway interest rates.

Chart of BAM's total long-term debt (quarterly)
Data by YCharts.

What helps save Brookfield’s bacon is that $173.09 billion of Brookfield’s debt is non-recourse, which means when one of Brookfield’s operating companies gets a loan, it’s is the subordinate operating company that is responsible for the loan. Additionally, the lender has no recourse to collect additional funds from the parent company, Brookfield, if the loan goes bad. So while non-recourse loans may appear on Brookfield’s balance sheet, it has no responsibility to repay them, thereby protecting the parent company.

Moreover, even if interest rates were to rise more than expected, Flatt said on the first quarter earnings call that even 5% interest rates are low by historical standards for business. Brookfield’s cash-generating properties and can be absorbed by the company’s margins. Interest rates are also unlikely to even reach the 5% level in the near term, as many experts expect a recession in the third quarter. Normally, the Federal Reserve will stop raising interest rates during a recession.

Brookfield is a great buy at today’s price

Although Brookfield expects to benefit significantly from the effects of inflation over the next 24 months, the market values ​​the company with a PEG ratio of just 0.9 – well below the ratio of 3.1 achieved in March 2021. Additionally, a PEG ratio below 1.0 suggests an undervalued stock.

Suppose you are looking for a company selling at a cheap valuation that can still outperform the market in the next few years. In this case, it is better to consider investing in few companies than Brookfield Asset Management.

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