KKR stock: A tougher 2022 for private equity (NYSE: KKR)

KKR & Co. (KKR) is one of the world’s largest alternative asset managers with over $471 billion in assets under management, recognized as a pioneer in private equity investing. The company has grown significantly over the past decade by aggressively deploying capital, including expansion into new asset classes and strategies. Indeed, the company just had a record period between 2020 and 2021 that was defined by higher overall asset prices and a booming IPO market. On the other hand, the stock has been caught in the current market volatility, with KKR down 30% from its recent high against both an implied reset in the valuation of some of its portfolio companies under underlyings and the upward trend in interest rates as an operational headwind. While KKR maintains a positive long-term outlook, we expect the stock to remain under pressure in a challenging environment for private equity.

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KKR Revenue Summary

The company shared its Fourth quarter results on Feb. 8 with non-GAAP EPS of $1.59, $0.38 ahead of estimates. Fee-related revenue in the quarter reached $606 million, up 45% year-over-year. There was also a strong increase in performance income and realized investment income, although this was offset by a corresponding increase in compensation as an expense. Regular wages also rose amid tight labor market conditions, a recurring theme on Wall Street and investment banking. The quarter ended an outstanding year for the company with the basic financial measure of after-tax distributable profit (NYSE: DE) at $3.9 billion or $4.44 per adjusted share, up 121% from the year-ago period.

KKR Earnings

source: IR company

During the fourth quarter, KKR raised $19 billion in new capital totaling $121 billion for the year. The company deployed $23 billion in the quarter and $73 billion for the year. Similarly, uncalled commitments at $112 billion, up 67% year-on-year, reflect the unfunded portion of capital available for investment that paves the way for future growth opportunities.

KKR Metrics

source: IR company

The story in 2021 was the massive increase in assets under management, which soared 87% year-on-year to $471 billion. Within this amount, the company Acquisition Q1 2021 of the “Global Atlantic Financial Group” was a big part of it, adding $90 billion to the total. Nevertheless, the 47% growth of AUMs last year recognized as “organic” is also impressive. This is explained by the strength at all levels between private and public market strategies, including raising capital and increasing asset prices.

Global Atlantic has brought a significant fixed income and annuity business to the insurance and reinsurance industry. Technically, Global Atlantic operates as a subsidiary with KKR holding a controlling 61% stake. The deal has helped diversify KKR’s broader business, with Global Atlantic now representing an important source of low-cost liabilities that can be used to fund KKR’s core business.

Operationally, some of the highlights of the fourth quarter include the sale of a minority stake in “Kokusai Electric”, a Japanese producer of semiconductor manufacturing equipment. There was also a secondary sale of “Max Healthcare” and the exit of “Apple Leisure” which all contributed to higher realized carried interest. Management notes that the traditional private equity portfolio appreciated 46% for the year, adding to assets under management. For the public markets segment, leveraged credit and alternative credit were a highlight in the results.

Growth of KKR metrics

source: IR company

A development of this report is that KKR is increasing its quarterly dividend by 7% to $0.155 per share for the next quarter. Historically, the payout has been variable with earnings, while this latest increase is now the 3rd consecutive year with a rate hike. The forward yield is around 1%.

While management did not provide specific guidance for 2022, comments on the earnings conference call suggested optimism. Fundraising was strong in areas such as real estate and a focus on Asia region strategies. The company is also developing its wealth management activity.

In the longer term, the company reiterates its outlook resulting from the Investor Day 2021 which included a target to achieve DE per adjusted share above $7.00 per share over the next 5 years, from $4.44 in 2021. The expense-related earnings per adjusted share target is to exceed $4 versus $2.23 in 2021.

KKR stock price prediction

We mentioned that KKR shares have been under pressure, selling with the broader market. Part of the challenge considers that after the spectacular 2021, the company will now face a difficult period of comparison in a high watermark of performance for its underlying strategies.

The big market theme over the past few months has been a sharp correction among high-growth and emerging tech companies from peak valuations in early 2021. The good news is that KKR portfolio investments have a good level of diversification at the sector level, but include exposure to growth and technology which have been particularly hard hit.

KKRPE

source: IR company

While we don’t have a breakdown of the current performance of all of KKR’s many private and public market investment vehicles in Q1 2022, it’s fair to assume that the portfolio’s unrealized returns are down from to benchmarks. Some of KKR’s equity investments made in 2021 are likely to be underwater at this point below the original cost base, which will translate into lower earnings going forward.

This dynamic is not limited to KKR. Among a group of other leading publicly traded private equity firms like Blackstone Inc (BX), Apollo Global Management Inc (APO), The Carlyle Group Inc (CG), Ares Management Corp (ARES), as well as the recent IPO of TPG Inc (TPG); all of these stocks are in correction territory as KKR underperformed.

Graphic
Data by Y-Charts

The upward trend in interest rates also represents a headwind for private equity. At the margin, the cost of funding is rising as its investor base loses some risk appetite amid the current market volatility for new investments.

We will mention that adding the insurance arm to Global Atlantic helps balance some of these implications as the business may even benefit from a higher interest rate environment. Yet it is understood that the insurance side of the business is small in the context of overall finances. Global Atlantic also has a liquid investment portfolio including stocks that are also under pressure.

Is the KKR overvalued?

In terms of valuation, one of the metrics we look at is the adjusted book value per share the company reported at $28.77, up 25% from $23.09 at the end of 2020. Interestingly, given the last stock price sell-off, the current stock price for KRR has risen by almost the same percentage over the period, implying that the valuation on a price per book value at around 2x is stable over the period. On the other hand, going further back, KKR traded at an adjusted price-to-book ratio closer to 1x at the end of 2019 and 1.3x from 2018.

Book value KKR

source: IR company

It can be argued that the addition of Global Atlantic justifies a higher premium, now adding a layer of quality to the business with more stable cash flow. That said, we would like to see a pattern of accelerating growth and improving earnings outlook to justify a higher spread that is lacking here in early 2022.

This same line of thinking can be carried over into the stock’s P/E ratio on a forward-looking basis quoted at 13.7x, which is above the 3-year average for the stock’s multiple closer to 9.4x. Again, there is not a single metric that will stand out showing that KKR is very over or undervalued. We believe it is important to place the numbers in the current market environment defined by higher volatility. We’ll take the middle ground and call KKR at least fairly valued.

Graphic
Data by Y-Charts

Is KKR a buy, sell or hold?

Putting it all together, it’s clear that sentiment toward private equity and alternative investments has been hit by exuberance in 2021. We rate KKR stock as a neutral position, balancing our sense that selling has likely already discounted some of the short-term headwinds in the face of lingering uncertainties. Again, the company is doing well, but we don’t see enough of it to make a very bullish call. With the financial sector, banks or even pure-play insurance will be in a better position to take advantage of rising interest rates.

The silver lining is that often during times of market distress the best opportunities arise for new investments. If there was confidence that equity and fixed income benchmarks were on the verge of a rapid return to an all-time high, we could see KKR outperform on the upside. At this point, the stock as a proxy for private equity becomes a macro trade.

The risk here is that of a further deterioration in the global growth outlook which would limit investment returns and put pressure on the operating environment. Monitoring points over the next few quarters beyond the evolution of distributable earnings include the level of new capital raised and the evolution of uncalled commitments.

About Andrew Estofan

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