November 29, 2008

Value Idea: BAM Preferred Shares

I have detailed my case for the Bookfiled Asset Management (BAM) preferred here. I will elaborate on some additional points on its investment merit.

I have picked issue, which has the following characteristics:

  • Floating rate issue, i.e., dividends change depending on the Canadian prime rate.
  • The issue is redeemable at BAM option at $25 per share, i.e., the issue has face value of $25.
  • Dividends are cumulative, i.e, if the BAM decides to skip a dividend payment then dividends would still owed to the investor.
BAM's preferreds offer me an excellent opportunity to earn great return that I could not simply pass up. I have bought BAM.PR.B at $7.9 per share to earn a dividend yield of 10.5% annually. There is room of capital appreciation as well. The face value of these preferreds are $25 per share; they are trading at almost 70% discount to where it was trading just a year ago. I do not think this price will be the absolute bottom but in the long run the odds are in my favour to earn
satisfactory returns.

Brookfield Asset Management (BAM) has four operating categories from which it generates cash flows:

  • Property: those are unique properties in supply constrained markets, mostly downtown properties in major urban centres, mostly through its ownership of Brookfield Properties (50%), another holding of mine, although it operates some properties on its own as well.
  • Power generation properties in demand stable markets like North east and west cost.
  • Infrastructure assets like transmission lines and timber fields.
  • Asset management for institutional entities. BAM uses these funds and co-invest with its clients in the above three categories. moreover it does manage security instruments as well.
BAM have great management talent, which its philosophy is to buy unique valuable assets at a fair price rather than average asset at a discounted price. See this presentation by their CEO to appreciate the value philosophy of this management team. Moreover, BAM has been creating value to its shareholders by spinning unique assets, like Brookfield Properties and Brookfield Infrastructure.

This is a bet not only on the assets earning power but on management to deliver value. I think betting on management was underrated in the investment discipline, where asset value and earning power was the focus.

Additional points of consideration:

  • Interest rate risk: these are floaters and their dividends payment correlate to prime interest rates, so the risk of more interest rate cuts will lower its payout. Retail investors mostly hold preferreds and their actions are mainly driven by fear, so these shares trade violently each day and sometimes their trading does not make much sense. At current prices investors are pricing them as if interest rates will never rise again. I betting that interest rates in few years will rise and will rise rapidly, in such case these preferreds will gain. However if they do not I am earning more than satisfactory returns.
  • You could buy fixed rate preferreds and you will do well but I would like to reduce interest rate risk from this issue and floaters are great way to do it.
  • Cash flow levels are solid: Currently BAM have about $3 billion of core liquidity and generate about $2 billion of cash annually. Moreover, FFO per share for the third quarter was US58¢, up from US51¢ in same quarter of the previous year. Excluding net gains and unpredictable items, BAM’s adjusted FFO available for common stockholders at US50¢ per share, up from US45¢ a year earlier. Adjusted FFO is funds from operations after the payment of all interest and expenses. It is not quite the equivalent of free cash flow, but a good indicator that BAM is a good generator of cash. BAM’s cash flows remain solid, while it’s financial position is strong an it is cash rich at a time when others face forced liquidations and cash is king.
  • BAM has maintained acceptable balance sheet ratios with just under 30% debt-to-total capital (book value) and cash flow-to-debt of 0.33. BAM’s coverage ratios also remained strong in 2007, with interest coverage on a remitted basis of 5.3 times and fixed charge coverage of 3.9 times.
  • Debt level: BAM Investment-grade financing strategy is to hold fixed rate, diversified and long-dated maturities. The strategy matches their assets and reduces any risk of funding miss match that could lead to asset fire sale or forced liquidation. Moreover significant chunk of BAM's debt is non recourse. This deb is associated with mortgages on their commercial properties. Why is this important? because no single property can take down the company if it ran into trouble.
  • In the event of balck swan bankruptcy, my capital hold a good probability to be protected. If we assume a 75% liquidation value of BAM long term assets there will be just enough funds to cover preferred holder and wipe out common equity holders. Off course preferred shares rank higher than common equity and should see full recovery of their book value; book value of all outstanding preferred is $870 million. And because we are buying those issues at deep discount we have almost 45% margin of safety.
BV As of Q3 2008
Recovery values
Liquid assets- values will hold
Long term tangible assets
Less all liabilities
Surplus available for preferreds and common equity

I am not only like their preferreds but I like their business model and management. I am looking at their common valuation to determine if an investment in their common equity is warranted.


Anonymous said...

great post I hold BAM and for the life of me can't understand why they have been clobbered so badly. I must admit I am quite happy after reading this to continue holding them.

Sami said...

I think it is just a matter of panic with every one else. thinking BAM is a commercial real estate company only.

I am happy to buy more of it.

Anonymous said...

Hi -- i use etrade and found BAM_PB:TSX. Is that the same shares you are referring to in this post? It is currently priced at $6. I like this idea, but just want to make sure i am buying the right guy?

Here is the etrade link for the quote (if you can reach it):

Sami said...

that is the guy. it is the one, the tsx symbol should be BAM.PR.B

Anonymous said...

Thanks. I picked up the shares today at $5.95.

One more question -- how often do they pay out the 10.5% annual dividend? Is it a quarterly/annual or monthly pay-outs?

Thanks for your great analysis on this.


Sami said...

no problem.

it is paid quarterly.


Bob said...

are the and M safe? Wonderful income producers for an old guy.