black stone (NYSE:BX) is arguably the world’s greatest alternative asset manager. First and foremost, it has $900 billion in assets under management by the end of Q1 2022, making it the largest alternative asset manager. Globe. Second, it has an exceptional track record of generating market-crushing total returns for shareholders:
Last, but not least, it has an A+ credit rating, one of the top in the industry.
On top of that, BX has two other key factors working in its favor. In this article, we discuss these factors, assess the current risks facing the business and provide investors with a common purchase price target that motivates us to add to our core and retirement portfolios among high yield investors.
#1. The medium-term outlook for alternative asset managers is very bullish
With interest rates near historic lows and below the inflation rate, despite rising rapidly in recent months, the environment is more favorable for alternative assets.
We believe interest rates are poised to remain in a lower band – and real interest rates are almost certain to remain negative – as huge government and corporate debt loads encourage negative interest rates and lower nominal interest rates.
This will prove a boon for alternative assets and alternative asset managers like BX as higher inflation increases the replacement cost of its vast empire of high-quality real assets while keeping yields competitive with traditional income investments like bonds.
We believe BX is poised to benefit from investments in infrastructure to meet the demands of the Fourth Industrial Revolution, as well as upgrade critical infrastructure that is obsolete and falling into disrepair across the Western world.
As peer competitor Brookfield Asset Management (BAM) put it on slide 7 of their September 2021 investor presentation, institutional allocations to alternatives have increased from just 5% in 2000 to 30% in 2021. By 2030, analysts expect the allocation to double to 60% again. This should provide a huge boost to BX’s fundraising efforts.
#2. Blackstone runs a truly fantastic business
The best deals are those where you can deploy retained cash flows at very high incremental rates of return. BX – which has consistently posted returns on equity north of 20% (barring a brief blip to the still-impressive teens during the 2020 COVID-19 pandemic) – sums up such business:
The company runs a very capital-light business model by effectively leveraging client’s capital. Meanwhile, given BX’s strong brand and unmatched global network of customers and partners, the company is able to quickly scale the business with minimal capital investment. This results in sky-high returns on investment and enormous amounts of free cash flow, with a policy of passing a large percentage to shareholders through dividends, while maintaining a very strong balance sheet.
What makes BX’s business model stand out even more is that it commands considerable pricing power and considerable client stickiness. In contrast to publicly traded debt and equity asset managers like BlackRock (BLK) that don’t really add much value to their investments and therefore offer little differentiation other than lower asset management fees, BX has a lot of differentiation from peers and is therefore much better. Price potential.
BX operates in less liquid and less efficient sectors of the global economy, where only large-scale players can compete for deals. As a result, it offers clients access to exclusive deals and asset classes where it leverages its expertise and unparalleled market data to optimize returns. This means that it can charge huge fees to its customers and lock them in for long periods, resulting in higher profits and greater stability of earnings.
BX Stock Risks
That said, BX is not a risk-free investment. The biggest challenge facing the company today – and the reason the share price has fallen in recent weeks – is that we believe the globe is on the verge of entering recession.
It’s a big deal that BX’s revenue stream is partially dependent on incentive fees. When the economy slows, property values often fall and fundraising momentum slows. This means that BX may see a decline in earnings. During the Great Recession of 2008-2010, BX’s earnings suffered significantly, posting a loss per share of $4.36 in 2008, followed by losses of $2.46, $1.02, and $0.57 per share in 2009, 2010, and 2011, respectively. For perspective, in 2007, it posted earnings of $1.45 per share, and in 2012 it recovered to total earnings of $1.77 per share. In 2021, earnings per share were $4.77.
Clearly, BX survived the recession and came out the other side remarkably strong, and we expect it to do so again during a recession. However, investors should still keep in mind that BX can suffer steep losses during recessions, which could lead to disappointing returns in the next few years.
BX stock purchase price
While we think the share price is currently attractive to long-term investors, there are also several other attractively priced alternative asset managers in which we currently invest. That said, as BX’s share price continues to decline, we’re getting more interest in buying it.
The stock looks fairly cheap based on its price-to-free cash flow ratio of 7.71x, lower than its historical average ratio of 8.60x. However, its price-to-earnings ratio is high at 16.03x compared to its historical average of 14.20x. Meanwhile, the dividend yield is below its historical average of 5.91%, though still attractive at 5.29%.
While these ratios — particularly the price to free cash flow ratio — are good if we’re convinced the company will continue to grow for the next few years, the truth of the matter is that a recession will destroy the stock price. Analysts expect earnings per share to grow from $5.68 in 2022 to $7.19 in 2025. Assuming the earnings ratio returns to its historical average of 14.20x, the share price stands at $102.10. When combined with an expected total dividend payout of $20.72 over that time period, we get an adjusted share price of $122.82. This equates to a CAGR of 8.9% from the current share price of $91.07. While we think this is a good return, nowhere near enough to warrant us adding it to our portfolio.
We can add BX to our portfolio at ~$80 per share, because at that level we expect to see ~13% annualized total returns between now and 2025.
BX clearly has a lot going for it and has a tremendous track record. However, a recession appears to be on the horizon, which will slow growth over the next few years. On top of that, despite the recent sharp pullback in the share price, the stock is still not particularly cheap relative to its historical averages. We believe the stock currently warrants a buy rating, but is not attractive enough relative to some of its peers to prompt us to buy it at this time. If it falls another 12-15%, we will upgrade it to strong buy and take it more seriously.