KKR & Co. (KKR) is one of the world’s largest alternative asset managers with over $471 billion in AUM, recognized as a pioneer of private equity investing. The company has grown significantly over the past decade by aggressively deploying capital including an expansion into new asset classes and strategies. Indeed, the company is coming off a record period between 2020 and 2021 which was defined by overall higher asset prices and a hot IPO market. On the other hand, the stock has been caught up in the ongoing market volatility, with KKR down by 30% from its recent high against both an implied reset of valuation for some of its underlying portfolio companies along with the trend of rising interest rates as an operating headwind. While KKR maintains a positive long-term outlook, we expect the stock to remain under pressure into a difficult environment for private equity.
KKR Earnings Recap
The company reported its Q4 earnings on February 8th with non-GAAP EPS of $1.59, which was $0.38 ahead of estimates. Fee-related earnings in the quarter reached $606 million, up 45% year-over-year. There was also a big jump in performance income and realized investment income although this was balanced by a corresponding bump to compensation as an expense. Regular salaries have also climbed amid tight labor market conditions which has been a theme on Wall Street and investment banking. The quarter capped off a blowout year for the company with the core financial metric of after-tax distributable earnings (NYSE:DE) at $3.9 billion or $4.44 per adjusted share was up 121% from the period last year.
During Q4, 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% y/y reflect the unfunded portion of available capital for investments that provides a runway for future growth opportunities.
The story in 2021 was the massive increase in AUM, which climbed 87% y/y to $471 billion. Within this amount, the company’s Q1 2021 acquisition of “Global Atlantic Financial Group” was a large part of that, adding $90 billion to the total. Nevertheless, the 47% of the AUM growth last year recognized as “organic” is also impressive. This was driven by strength across the board between private and public market strategies including the capital raised and increase in asset prices.
Global Atlantic brought over a major fixed income and annuities business within the insurance and reinsurance space. Technically, Global Atlantic operates as a subsidiary with KKR owning a 61% controlling interest. The deal helped to diversify KKR’s broader business with Global Atlantic now representing an important source of low-cost liabilities which can be leveraged as funding for KKR’s core business.
Operationally, some of the highlights from Q4 include the sale of a minority interest 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 the AUM. For the public markets segment, leveraged credit and alternative credit was a strong point within the results.
A development from this report is that KKR is hiking its quarterly dividend by 7% to $0.155 per share for the next quarter. Historically the payout has been variable depending on earnings while this latest increase is now the 3rd consecutive year with a rate hike. The forward yield is right around 1%.
While management is not providing specific guidance for 2022, comments during the earnings conference call projected optimism. Fundraising has been strong across areas like real estate and a focus on Asia region strategies. The company is also expanding its wealth management business.
Longer-term, the company is reiterating its outlook issued from the 2021 Investor Day event which included a goal of reaching DE per adjusted share above $7.00 per share over the next 5 years compared to $4.44 in 2021. The target for fee-related earnings per adjusted share is to climb above $4 compared to$2.23 in 2021.
KKR Stock Price Forecast
We mentioned that shares of KKR have been under pressure, selling off with the broader market. Part of the challenge considers that following the spectacular 2021, the company will now face a difficult comparison period into a high watermark of performance for its underlying strategies.
The big theme in the market over the last several months has been a sharp correction among high-growth tech and emerging companies compared to peak valuations at the start of 2021. The good news is that KKR portfolio investments do have a good level of diversification at the sector level, but does include exposure to growth and tech that have been particularly beaten down.
While we don’t have a breakdown of the current performance for all of KKR’s numerous private market and public market investment vehicles into Q1 2022, it’s fair to assume that unrealized portfolio returns are down alongside benchmarks. Some of KKR equity investments made in 2021 are likely underwater at this point below the original cost basis which will be reflected into weaker earnings going forward.
This dynamic is not limited to KKR. Among a group of other high-profile publicly-traded PE firms like Blackstone Inc (BX), Apollo Global Management Inc (APO), The Carlyle Group Inc (CG), Ares Management Corp (ARES), along with recent IPO from TPG Inc (TPG); all these stocks are in a correction territory while KKR has underperformed.
The trend of rising interest rates also represents a headwind for private equity. At the margin, the cost of funding goes up while its investor base losses some of the risk appetites amid the current market volatility for further investments.
We will mention that the addition of the insurance arm with Global Atlantic helps to balance out some of these implications considering the business can even benefit from a higher interest rate environment. Still, the understanding is that the insurance side of the business is small in the context of overall financials. Global Atlantic also holds a portfolio of liquid investments including equities that are also under pressure.
Is KKR Overvalued?
In terms of valuation, one of the metrics we’re looking at is the book value per adjusted share which the company reported at $28.77, up 25% from $23.09 at the end of 2020. Curiously, considering the latest selloff in the stock price, the current price of shares for KRR is up by nearly the same percentage over the period implying valuation on a price per book value at just about 2x is flat over the period. On the other hand, going back further, KKR traded at a price to adjusted book ratio closer to 1x at the end of 2019 and 1.3x from 2018.
A case can be made that the addition of Global Atlantic justifies a higher premium now adding a layer of quality to the business with more stable cash flows. That said, we’d like to see a setup of accelerating growth and improving earnings outlook to justify a higher spread which is missing here at the start of 2022.
That same line of thinking can be carried over into the stock’s P/E ratio on a forward basis listed at 13.7x, which is above the 3-year average for the multiple for the stock closer to 9.4x. Again, there’s not a single metric that will stand out showing KKR is very over or under-valued. We believe it’s important to place the figures into the current market environment defined by higher volatility. We’ll take the middle ground and call KKR at least fairly valued.
Is KKR a Buy, Sell, or Hold?
Putting it all together, it’s clear that the sentiment towards private equity and alternative investments has taken a hit from the exuberance in 2021. We rate shares of KKR as a hold representing a neutral view, balancing our sense that the selloff has likely already discounted some of the near-term headwinds against ongoing uncertainties. Again, the company is fine, but we don’t see enough to make a very bullish call. With the financials sector, banks or even a pure-play on insurance will be in a better position to take advantage of climbing interest rates.
The silver lining is that oftentimes during periods of market distress the best opportunities arise for new investments. If there was confidence that equity and fixed income benchmarks were set to quickly snap back towards an all-time high, we could see KKR outperforming to the upside. At this point, the stock as a proxy for private equity becomes a macro trade.
The risk here is for a further deteriorating to the global growth outlook that would limit investment returns and pressure the operating environment. Monitoring points over the next few quarters beyond the trend in distributable earnings include the level of new capital raised and shift in uncalled commitments.