Brookfield Corporation (BN) Q1 2013 Earnings Report, Transcript and Summary

Hello. This is the Chorus Call conference operator. Welcome to the Brookfield Asset Management 2013 First Quarter Results Conference Call and Webcast. [Operator Instructions] The conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Katherine Vyse, Senior Vice President, Investor Relations for Brookfield Asset Management. Please go ahead.

Thank you, Laurie, and good afternoon, ladies and gentlemen. Thank you for joining us for our first quarter webcast and conference call. On the call with me today are Bruce Flatt, our Chief Executive Officer; and Brian Lawson, our Chief Financial Officer. Brian will start this afternoon discussing the highlights of our financial and operating results. Bruce will then discuss our views on the current investment and market environment as well as a number of our major growth initiatives in the quarter. At the end of our formal comments, we will turn the call over to Laurie again to open it up for questions. [Operator Instructions] I would at this time, remind you that in responding to questions and in talking about our new initiatives and our financial and operating performance, we may make forward-looking statements. These statements are subject to known and unknown risks, and future results may differ materially. For further information for investors, I would encourage you to review our annual information form or our annual report, both of which are available on our website. Thank you. And I'd like to now turn the call over to Brian.

Great. Thank you, Katherine, and good afternoon. We finished our -- just finished our annual shareholder meeting this morning, and as is our custom, we'll keep our comments a bit briefer than usual. Our financial performance for the first quarter was very good. FFO for the quarter was $689 million or $1.03 per share, and that's up 34% or $174 million over 2012 quarter. $150 million of the increase came from improved operating results, and gains increased by $26 million. The largest increase came from our housing-related businesses, in particular the panel board and lumber operations held within our private equity operations. In total, FFO from these operations increased by more than $65 million. Asset management service activities increased by $35 million, largely driven by increased asset management fees, in particular base management fees and also from a return to a more typical contribution from our construction business. Our power operations benefited from improved spot pricing and the contribution from new facilities to increase their contribution by $19 million. And we also benefited from the contribution from new property and infrastructure businesses, as well as increased rents in our office and retail property portfolios. The disposition gains during the quarter totaled $325 million. Notable transactions were the sale of 8 million units in our renewable energy entity and 3 million shares of Norbord, one of our panel board companies, for a combined proceeds of nearly $350 million. Net income declined slightly quarter-over-quarter to $689 million, including noncontrolling interest. The pickup that I just spoke about in our operating results was offset by a decline in valuation items. We did record approximately $400 million of valuation gains on our property portfolios due mostly to improved cash flows, but these were lower than the gains recorded in the prior period, hence, the quarter-over-quarter decline, but still good results. The key operating highlights included the following: Base management fees and incentive distributions increased by 34% and now stand at $500 million on an annualized basis. Fee-bearing capital under management increased to $74 billion with the launch of Brookfield Property Partners and other capital increases. Accumulated carried interest increased by $35 million to $724 million. As I mentioned, we are beginning to see the benefits from the capital we deployed in the housing-related businesses during the downturn, both in terms of increases in funds from operations, as well as increases in the stock market values for our investments. Prices for the OSBs produced by our panel board companies doubled over the first quarter of 2012, and our North American residential backlog has increased 40% compared to that quarter as well. In our office business, we leased 1.3 million square feet at rents that were 16% higher than the expiring rents. Income -- net operating income from existing properties increased by 2.4%. In our U.S. retail portfolio, sales increased by 6% year-over-year to $519 per square foot on a trailing 12-month basis, and funds from operations from this business increased by 15%. Our power business benefited from higher spot prices, as I mentioned, for uncontracted power and [ph] a contribution from new facilities. Generation was 3% over our long-term average, and reservoir levels are good, setting us up nicely for the balance of the year. Our Infrastructure business benefited from the completion of the expansion of our rail lines in Western Australian in particular and the contribution from assets acquired in the last half -- latter half of last year and stronger pricing in our timber operations. We continue to capitalize on low interest rates and receptive capital markets to raise liquidity and extend our financings at very low rates. This has allowed us to replenish liquidity and lower our overall cost of capital. So all in all, it was a very strong quarter from both an operational and financial perspective and the one that positions us very nicely going forward. And before I hand the call over to Bruce, I would like to add that the Board of Directors has declared a dividend, the regular quarterly dividend, of $0.15 per share payable on August 31. Thank you.

Thank you, Brian, and to everyone for joining. First, with respect to the mark -- overall markets that we operate in, business conditions are good. And in particular, financing markets remain very strong, and we continue to utilize this global market reflation to extend maturities of our financing and to sell nonstrategic assets to continue to restock liquidity, in particular, after major investments made in the period of '09 to 2012. As Brian mentioned a couple of them, we sold a number of non-core security positions and real estate and timber assets and generated about $1.2 billion of cash during the quarter, and we're continuing this program in all of the operations given that markets are strong. In particular, we expect that current slow-growth, low-rate interest rate environment to persist accompanied by the unprecedented Central Bank liquidity and with a lack of catalyst for a more robust economic recovery. As a result, this environment, we believe, is an exceptional -- will provide demand for exceptional amounts of income-producing assets, which have upside potential, and this will continue to accelerate as investors, both in the private and the public markets, seek both yield, stability and growth offered by this type of assets. As a result, real assets should continue to emerge as an even more compelling investment alternative as they offer these -- all of those attributes: current yield, stable bond like cash flows, tangible growth and, in fact, the hedge against future inflation in many cases. In a slowly improving economic climate and with the opportunity to invest in sustainable cash flows, offering meaningful current yield is extremely where we believe real assets will continue to be an exceptional investment. Dealing more on a micro level, housing starts in the United States continue to surprise on the upside, which I guess we've been seeing for the last 24 months. They rose to almost 1 million units on an annualized basis. Moreover, unsold home inventories in U.S. continues to drop below precrisis levels, and that suggests that homebuilders will need to continue to build more to prevent the inventories from going lower. We expect the housing rebound will have strong spillover effect both for the consumer spending and business confidence. Good for all businesses, but specifically related to all of the housing-related investments that we made, as Brian said, over the past 5 years. We're active in all of our businesses putting capital to work. In addition, we, as I said earlier, have been harvesting cash from mature or noncore investments. More recently, we have been liquefying assets, and I guess what I'd say, and we often get asked about this, is that people shouldn't -- should read really just 2 things into that fact. And the first is that markets are good and, therefore, we often or always try to use that environment to sell noncore, nonstrategic or overweighted positions and realize cash on to the balance sheet. And the outflow from that is that we have significant cash on the balance sheet to fund major investment opportunities that we see. And I can tell you today that in all of our businesses, we have a number of things that we're quite positive about that we will be able to put money to work in. So we're both raising cash for that purpose and also just using the environment in a very active way. We often -- lastly, we often get asked about our view on interest rates and where they're going, but in particular on how they affect our businesses. And in this -- I guess our view generally is in this economic environment that we're in, we believe that the type of assets we own are the place to be. I'll briefly cover, in a second, why we think that. But we'll also attempt over the next year, sometime in one of our shareholder letters or maybe on a conference call, to lay out our thesis more substantially and more empirically. It's safe to say, though, that it is clear to us that interest rates are at historic lows. And that while maybe not in the immediate term, the cost of borrowing will rise at some point in the future as there's very little room to go. And that premise is based on the fact that we don't think the United States is Japan and that, therefore, there's a greater chance that rates will increase. And our goal as a result of that is to ensure that we protect our organization and our clients and investors as much as possible against this risk. We believe that there's really 2 ways to do that, and the first one is that we continue to use these capital markets to lock in as much of our debt at very low coupons for as long as we possibly can, and we will continue to do that over the next period of time as much as we possibly can. Secondly, and as importantly, our business model has been focused over the past 10 years on owning high-quality real assets, which tend to increase in value at a rate that exceeds inflation. And in a deflationary environment, the cash flows that come out of them are extremely valuable. But more importantly possibly is that they also often have leases or contracts that feature inflation protection, and therefore, in an inflationary environment, you will ultimately catch up the cash flows along with inflation. And that's a very important attribute to the type of assets that we own. So while I say we're immune -- we're not immune from the impact of global economic trends, we believe we will continue to prosper in these low interest rate environments, and in addition, as rates ultimately move up, and as I said, more on this when we talk in the future. So with that, I thank you for your time and thank those that came out and listen to our annual meeting today. And I will turn it back to the operator if there are any questions from anyone on the call.

[Operator Instructions] The first question today comes from Bert Powell of BMO.

Bruce, you said today in your remarks at your AGM, you're still fairly bullish on Australia despite a lull. I'm just wondering thinking about your portfolio in its entirety going forward and the drivers for different economies and different geographies, how comfortable are you increasing your concentration for Australia, given that's a resource-focused economy?

So it's a good question, and we -- I guess, Bert, I would say the following. We generally have areas where we invest and we get comfortable with, and where we just continue to keep investing as long as we believe the macroeconomic trends longer term are good. And if we believe there's going to be a period of time when there'll be a rougher economic situation, we'll try to make sure we have all fixed-rate financing and pay down the financing on assets and make sure we can live through it. But that doesn't mean that we'll leave an area of the world where we're comfortable in investing. And I guess that comment I'd make about -- specific about Australia is we believe it's one of the great markets to invest in the world because it has an enormous amount of resources with a small population. It's a very wealthy place. And it's driven a lot by the Asian story. And while there may be hiccups along the way, the next 30, 40, 50 years of the world is going to be a lot driven by the Asian economies. And therefore, Australia, in many different ways, is going to benefit from that, and I guess we see very substantial fund flows into that economy to build out natural gas, iron ore and other commodity-based projects, which aren't stopping. So generally I'd say we're -- there comes a point I guess where you have to be -- limit how much capital you have in a place, and usually we can manage that on our own balance sheet by bringing further clients into it in a greater way, and that just broadens our organization. So I'd say we still view it as a very positive place to invest, and we'll continue to put more money there.

Okay. And just a curiosity. I know this probably isn't that material, but the investment you have in Maax, the bathroom place through your private equity business. I'm just wondering if you're starting to see any signs from that business that tells you the U.S. housing is starting to have more of that spin-off effect. Are you seeing it showing up in that business? So we know the OSB business is good, but are you seeing in that business?

Yes. Just for everyone's benefit, this is in our private -- one of our private equity investments in our private equity capital fund, and it makes bathroom fixtures. I think it's the second-largest fixture maker in North America. And as a background, when we say we see all of the business that we're involved in that are related to housing more positive today than they were before, it's every single investment we have related to housing, and it includes that one. So there's no doubt it's -- it has started to turn, and we see it in the numbers there. There's still a long way to go for a number of these businesses over the next 5 years. But it definitely is more positive than it was 2 years ago as is every single one of those businesses like OSB and others.

The next question comes from Brendan Maiorana of Wells Fargo.

This is probably for Brian. But if I look at your proportion of leverage, unless you guys put it in the supplemental, I think it's 49%, and I guess that maybe the disclosure changed around a little bit from yearend with some of the stuff that's in and out of that. But as you sort of think about that number and how you like to broaden your balance sheet and a lot of secured debt and then debt at the subsidiary level and then not a lot of the corporate level, how do you think that 49% fits sort of where we are in the cycle? Can you move that -- would you be comfortable moving that leverage number higher or do you think that number needs to go lower or do you think that's sort of a good mid-cycle number to kind of target for your balance sheet?

Yes, Brendan. It's Brian. Yes, we're very comfortable with that level, and it could -- it all depends on the type of assets that you're owning as well. One of the reasons why we're very comfortable with it is if you think about that level in the context of the type of assets that make up most of our balance sheet, the high-quality office properties and power dams, infrastructure assets that's a very solid investment grade number. It's probably tweaked up a little bit over the prior years in part because this is more driven off of our book values. But it's very much in line with where we would see it going down the road as well.

And so as you sort of think about monetizing assets, as you guys talked about, I guess it would strike me that maybe you're going to monetize some of the more private equity type of businesses that have low current cash flow or have had low current cash flow over the past couple of years. And is that more likely to be recycled into the hard assets, which have probably higher current cash flow and sustainable cash flow?

I'd say not necessarily. Well, okay, so starting off with the various points of your question, and Bruce may want to add something as well. I think it is fair to say that we're focused on a number of those private equity -- of the investments in our private equity area in the near term over the next little while. In part, because of that whole theme of us putting a fair bit of capital into home, housing-related businesses over the past number of years, and now we've seen the results really start to come through. Market values pick up, and the very attractive investments, and so that it makes a lot of sense for us to harvest some of those gains. And some of that capital is going to go back into the private equity business. We do have new funds there that we're investing, and so we'll be putting more money into the investment so that -- in the private equity side of it. And it may well work its way into the other parts of the business, but that really will be more related to where we see the opportunities arising.

Brendan, the only thing I'd add to the question, maybe just more broadly, is generally, at the bottom of the market you own assets and you buy assets, and you accumulate [ph] -- and we bought a lot of assets in '09, '10, '11. And you end up with a lot of, I'll call it, noncore and tertiary assets that you otherwise might have sold at the time. But because the markets aren't liquid, there either is not a market to sell them or secondly, you don't like the price. As markets inflate over time as their recovery happens, there is -- you can harvest capital from those. And so a lot of the cash raising we're doing in many places is getting rid of the tertiary or noncore things that came along with other acquisitions. And it's a lot of capital. And it will be poured back into great long-term real estate infrastructure and other businesses in the businesses we have or into our private equity investments, which eventually form -- sometimes form the basis of our other businesses.

Yes, but it sounds like you're not actually, let's say, liquidating them and maybe shrinking the net investment today, right? I mean, you're liquidating the noncore assets and redeploying into stuff as opposed to sort of holding on the cash for a little while, right?

Yes. Like our general view, especially in a environment that we're in today, is there's a good bid for many things that are out there. And therefore, our general, from history, our general mind has been if we can liquefy our balance sheet as much as we possibly can, there inevitably will be opportunities that come along to deploy that capital into. And we're not sure where they are or which ones they will be, but there's going to be opportunities. And the more liquid we are, the better situation we're in to be able to capitalize on them. So that's generally what we've been doing.

The next question comes from Alex Avery of CIBC.

I just wanted to delve a bit further into that. I guess the terminology in your letter about restocking liquidity would seem to suggest that at least for a period of time you were thinking about, I guess, liquefying some of these assets and maintaining lower leverage. Would that be fair to say?

I would -- the only thing I would add, I'd say yes. The only thing I would add to that is that often we come across opportunities, and there are many that we have on the horizon. And if one of them comes through, we may use a lot of that liquidity in various places. But they may not come along, and markets just may be good, and therefore, we won't be able to use it. But I guess we view the optionality of holding greater liquidity in the organization is always worth it. And at times like this, it's a good thing to put more cash into the balance sheet to be able to transact, should it come along -- should something come about.

Okay. And then would it be possible to provide a range of perhaps the magnitude of volume of monetizations or liquefactions that you are targeting or hope to achieve?

I don't think Brian or I have a figure but because it's -- because it's in many different places. If you look at our Retail business in the United States, we've been selling noncore assets that came along with the GGP acquisition, and GGP has been selling assets and is sitting on cash now. In the office company, we've been selling. In infrastructure, we've been selling. In renewal power, we've been doing a few things around the edges. In all of our private equity businesses we've been monetizing different things, and on our corporate balance sheet, we've been doing it. It's many billions, many, many billions. But it all doesn't flow up to the band level, and it's in the businesses that we have as well.

Maybe I'll add 2 things to that. One is just okay, so very -- if -- we don't want to give the impression that you should expect to see us putting a whole lot of -- if we've got $4 billion of liquidity amongst various entities, we're not looking for putting multiple of that into the balance sheet. We also do see a high potential to put a lot of good capital to work. But there's also -- we are also are very focused on keeping a high level of liquidity in the business, particularly as the business expands. So I'll just add those 2 things.

Okay. Yes, I mean, it sounds like you'll be I guess making decisions on capital allocation as opportunities present themselves. But what I was sort of digging at was, I guess, presumably with a lot of these modernizations, you'll be able to realize some of your deferred performance fees?

That -- well, that -- yes, that definitely helps, and it's a combination of monetizing plus also getting towards the end of the fund life. So it will definitely help in that regard.

So we'll probably see a pickup over the next year or 2?

Yes, the next 1, 2, 3 years, yes.

The next question comes from Andrew Kuske of Crédit Suisse.

I guess if you just look back, it's been 5 or 6 years since the launch of Brookfield Infrastructure Partners as your first real big LP vehicle, public LP vehicle. So how has the compensation approach to your investment professionals sort of changed or evolved from, say, 10 years ago to the launch of BIP to where we are today?

So I think I can answer your question, or I think I know what you're getting at, but if I don't get this right, please ask me again. And I guess I would just say that for the senior members of our team and senior investment professionals and senior corporate people, the compensation's identical to what it was 10 years ago, which is a base salary, a bonus, which are relatively modest compared to industry standards and significant upside if the stock does well being Brookfield Asset Management shares. As we've evolved our compensation plans down below for other people within the organization, some have the same exact methodology that those senior people do. Others have the same methodology, but it may be based off of some other investment units, and it always has been. So it could be a specific unit. And if that's all the person is responsible for, the methodology is the same, but it may be a different metric. So I'd say almost -- it hasn't -- I don't think it really has changed at all other than some of the methodology calculations are different for specific parts. For example, there may be a fund in a business unit, and if people are only working on that fund, they largely derive their compensation drive out of that unit. But other than that, it really hasn't changed.

Still all very long-term equity base.

Okay. That's very helpful, and then just as it relates to, say, the fund origination part or new client LP money coming in, has there been any change in compensation practices for fundraising?

So we made a decision 10 years ago that we weren't -- we were not going to change our methodologies with compensation to what the private industry might have -- private equity fund raising industry might have been used to at the time. And I'm proud to say that we've been successful in raising all the money we have because we sold Brookfield as an organization, and the risk management and investment capabilities that we have within the organization as a whole. And that includes the compensation policies we have, and it's widely accepted today by virtually all the people or all the people that invest with us. So I think it's -- that's a positive, and it really hasn't changed anything with how we compensate people.

Do you see other alternative firms changing closer to your compensation structures?

I don't really know. I guess as some of the comparable organizations go public, they have the opportunity to do some of the things that we do, and I suspect some of them will. I also expect some of them won't, and they'll just stay with what's worked for them. Compensation, as everyone on the call knows, is an art, not a science, and it's very hard to do. And if you get used to a plan, you usually sort of stick with it if it works for you. So I think maybe they have the opportunity to do some of the things that we do now, and some of them probably will and some won't.

The next question comes from Michael Goldberg of Desjardins Securities.

A couple of number questions out of the supplementary. So on Page 5 of the supplemental, it shows $50 million of valuation gain out of corporate and unallocated, including $12 million of prepayment penalty on debt redemption. What's the other $62 million?

Those would be -- a large component of those, Michael, would be portfolio gains. We do have a large portfolio of financial assets, and we had a pretty good performance in the first quarter of 2013, actually in the first quarter of 2012 as well.

Okay. So nothing specific that you could point out?

No, no. That was pretty broad-based.

Okay. And separately in your renewable power, and I'm looking at Page 22 of the supplemental, you show a number of $7 million in addition to FFO because of hydrology being above long-term average. So is this what I could think of as being the hydrology gain or loss that I often ask you about that it be comparable to a $20 million negative item in the fourth quarter?

Yes. So it's not quite that, Michael. What that is, is from growth initiatives. So we -- there's close to 1,000 gigawatt hours that came from a number of the acquisitions and the facilities that we developed over the past year. And that $55 million of revenue gave rise to $7 million of FFO during the quarter. The difference between the 2 being the associated interest expense on the project debt and also the fact that a number of these projects were bought -- were acquired in funds, and so hence, we share the ownership of the facilities with our investment clients.

Okay. So in that case, what would be hydrology gain? I presume it's a gain this quarter have been compared to the $20 million negative. And what that [ph] comparable number have been in the first quarter of 2012?

Okay, let me see if I can work my way through that one. So as a general rule, okay, so just to break down the variances there. The pricing as we mentioned, so we went up by about $19 million overall. So let's say we went up by about $25 million for the pricing. We added another $7 million for the growth initiatives that I just talked to. And then generation was -- while it was still above average at 3%, you may recall in the first quarter 2012 it was particularly good in terms of being above average. And so on a quarter-over-quarter basis, same-store, we were down around $15 million of FFO. So it was $25 million plus $7 million less $15 million is right around that $19 million. Does that help?

So, Michael, maybe just to clarify. Because I actually was -- when I looked at the numbers, it was the same thing. Is it -- 2012 was a brutal year for water except the first quarter was very good.

Yes, second and third quarter that fell off.

Right, which happens to be now we have pretty good water levels. So it should be different this year compared to last year.

Okay. Maybe I should follow this up offline.

That would probably be easier.

[Operator Instructions] The next question comes from Cherilyn Radbourne of TD Securities.

So one of the themes we've been discussing on these calls for some time is increasing institutional allocations to real assets. And I just wondered if you could address how many real asset managers you think institutions will invest with on average as they make that shift. And do you see that increasing or decreasing?

So I don't -- I think it all -- I think it depends on the type of manager, how big they are and how they run their operation because there's all types. I guess I'd say I think small managers are more focused managers, will probably invest with less than 10. And it depends on whether you include real estate and infrastructure in the same -- in that category. Others take a more broad approach. But I'd say -- and would have many more. In general though, institutional clients, and you probably well know this, have been trying to focus down on groups where they can get -- have a more broad institutional relationship. And I guess that's something we believe is a large advantage to us. And then if we get to know the Chief Investment Officer and the people that run real assets in a business or in an institutional client and we bring them one fund, not only will we bring them the successive fund in that series, which we do, if we do a good job for them, but we will be able to bring them other products from our other areas. And because they know us and they trust us, they will invest with us. So I think what is generally happening in the world, just like everything, is these industries spun out and then they concentrate down. And you've seen it in fixed income. That's been a 35-year evolution, where there were hundreds and hundreds and hundreds of managers and now we're down to 5 major ones and probably 5 others that manage bonds for people in the world. In equity, that's more broad. In real assets, I think you will end up with 10 major complexes that can provide what we do to institutional clients, and we hope to be one of those. And so I think that generally the same evolution in the capital markets is happening.

Okay. And just a question on your public securities mandate. So I guess I've been under the impression that, that was an area that perhaps you were de-emphasizing strategically, but you did have a pretty big increase in the quarter. And I think in the supplemental, there's mention of a new mandate. Can you just give us a bit more color there?

So I don't have the specific numbers. Maybe Brian can tell you about them if it's just for -- if it's relevant. But no, in fact, we haven't been de-emphasizing it. But there's -- so we, just for everyone's benefit, we manage in addition to the private equity entities that we manage, we run listed securities in mandates for infrastructure and real estate. And in particular, our infrastructure funds, we have both European usage funds and U.S. mutual funds plus separate accounts. And we've collect -- we've been attracting a lot of money in the infrastructure side. And we think, again, with our track record in infrastructure more broadly and with the very good 3-year now track record, very few other people have those 2 things. And therefore, if people want to invest in infrastructure and they don't have the -- they can't do nonliquid strategies meaning private equity funds, we think that the listed strategies are highly attractive. And we're one of the few managers in the world that offer a focused product like that, and so we've seen a lot of money coming in, and we think it will continue to come in just like into unlisted infrastructure and real estate.

Okay. And the last question is really just seeking a bit of clarification. But the annualized base management fees of $500 million that you mentioned, is that inclusive of BPY or do we need to add $50 million on for BPY?

No. That's inclusive.

There are no more questions at this time, I will now turn the call back over to Katherine Vyse.

Thank you very much for joining us today, and we look forward to updating you next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.