I wrote about the private equity firm Carlyle Group (NASDAQ:CG) at the end of 2021, calling it neutral before considering it a “PURCHASE”. Certain developments, namely the war between Ukraine and Russia, made negative developments more significant for Carlyle, and the company is now is expected to post negative results for the full year in terms of earnings.
However, at worst, I consider it a momentary speed bump. Carlyle Group, despite having no credit rating, is one of the best and safest private equity firms. With a rising yield and a double-digit rise, I consider CG a “BUY” – and I think it’s time to think about it more seriously soon.
Let me show you why.
Carlyle Group – Exceeding my expectations
Let me start by saying that the decline in the company’s share price has little to do with the actual long-term overall impacts on the company’s bottom line. The company actually released 1Q22 results not too long ago, and while there are near-term challenges due to the invasion of Ukraine, rising interest rates and to macro uncertainty, the foundation of this company’s positive thesis is entirely intact.
The company’s ERF is up 40% year-on-year, and the company is responding to the macro by focusing on its diversification, with more than 65% of its assets under management not focused on corporate stocks at all . One would expect that a company that has fallen 20% in a short period of time would have significant exposure to Russia or Ukraine, but that is not the case.
CG has very minimal exposure not only to Russia, but also to Belarus and Ukraine. The company saw only a very minimal business impact from all of these issues.
You might expect a company with a negative performance of 20% since my last article to have seen significant impacts on its portfolio with impairments. The opposite is true. CG’s overall investment portfolio appreciated 5%, with global equities up 7%, while public markets, for comparison, fell by the same amount.
Real estate did what it does during inflation – it appreciated about 10%, and the company’s infrastructure/natural resources platform rose about 19%. This was all part of the company’s accumulated performance revenue balance which reached $4.3 billion, which is a record high for the company.
The lending business is performing well, yielding just north of 9%, and the company’s market-leading CLO business has a default rate well below the industry average, somewhat confirming the rise and fall. overall stability here.
The company continues to focus on growing its global credit platform with accredited mergers and acquisitions, such as the recent iStar and CBAM transactions. Fundraising continues to not be a problem for the company even in this environment, and the company managed to raise approximately $9 billion in funds during the quarter.
Overall, these trends have really accelerated the company’s FRE. For comparison, in 2017 the company generated just over $170 million in fee-related revenue. That number has now reached $600 million in 2021 alone, meaning CG has managed to triple it in 4 years – and the company continues to expect FRE to increase to over $850 million this year. , which puts 40% year-over-year growth for 1Q22 as the target for the full year. If achieved, this is 4X FRE growth in 5 years, demonstrating significant value creation on the CG side.
The end goal is to transform Carlyle into a more diversified global private equity/investment company, trying to seize opportunities in attractive areas such as global credit, infrastructure, renewable investments, insurance and other areas.
On the one hand, CG is a major player in investments in Energy and the energy transition. The company is already preparing for investments in this sector, but legacy carbon investments with an ESG footprint, as well as renewable/new investments with the right return profile. There are changing dynamics in the PE segment. With the record number of funds reaching the market, there will be a longer time frame for traditional PE fundraising – but CG is no longer a company that only has (large) exposure to PE fundraising , but fundraising options across the spectrum.
Carlyle’s concern seems to be that the company won’t be able to perform well now that the trends are turning more negative. Indeed, if we look at the company’s earnings models, we see incredible years followed by lean years with EPS declines of between 20 and 40%.
However, this was partly due to the company’s poor FRE until 2017 – that has changed today. I think the portfolio changes and the fundamental restructuring of the company have transformed CG into a more resilient, less cyclical company that will likely see fewer dips and more stability going forward.
Also keep in mind that an early investment in CG in 2012 actually outperformed the market by a decent amount with an annual RoR of almost 9.5%. If you apply any valuation consideration to this and buy the business at a low price, that RoR can easily go up to 20% per year, bought in 2014-2016.
The company’s FRE for 2022E is unchanged. Guidance remains 40% higher than 2021, and CG expects continued strong performance, and the company is on track to meet all of its stated targets.
While I am aware that some might expect the company to perform poorly here, I am clear that these expectations are not based on company forecasts or expectations, but perhaps more on the story.
Let’s get to the evaluation.
Carlyle Group – Valuation
Remember that this company is now the largest CLO manager in the world. And the company is trading at what can only be described as very poor valuations of nearly 8x the average P/E, compared to a 5-year average P/E valuation of 13.5x.
You will never find me investing in high yield CLO funds or products with 9-15% yields. It’s not my style of investing. Even when exposed to risks like this, I always try to maintain my conservative approach. In this case, that includes CG’s 3.45% return, invested in a multiple of 8X.
Even in the unlikely scenario of the company’s EPS halving in 2022, the company would still be able to cover its current, as well as the expected increase in dividends payable to shareholders. I think due to the current global situation, CG will drop in EPS, but I don’t see a 30-40% drop here. I also consider it likely, given the growing diversification and international appeal of the business, that it will be able to leverage this to increase EPS in 2023 and 2024, essentially remaining at a level of 3.8 to 4.8 dollars for the entire next 2 to 3 years.
This has the very real potential for valuation outperformance – partly due to valuation multiples reversing towards a fairer 10-13X P/E, but also due to EPS growth. I consider the likely upside for CG to be at least 25% per year in the long term, with a 2024E RoR of 81%, making it a great potential investment.
It may not be as safe as some of my other investments with similar benefits – referring to the company’s lack of credit rating. The key to understanding a private equity firm like CG is understanding the intricacies of its business and its approaches – and CG has proven that despite volatility, the firm is able to leverage various global situations to advantage and produce positive results for its shareholders.
With forecast accuracy being poor, I would caution investors against going too far into CG here. S&P Global analysts are calling CG a “BUY” with an absolutely massive rise in 67.7%, with 10 out of 13 analysts calling it either a “BUY” or an “Outperform”. This is the highest undervaluation CG has seen in some time, and I can only agree with this assessment, even if I disagree with the price target exact current for the company.
At most, to stay conservative, I’ll stick with an 11X 2024E PT which works out to around $55/share, as I said in my previous article. But due to the company’s performance and direction for 2022, I’m sticking to that goal and view the CG as more supportive now than I did in my last post.
My thesis for Carlyle is as follows:
- Carlyle Group delivered superb 2021 results that provide a great low-end EPS scenario for a good 2022. I think management’s confidence is warranted here despite (and also because) a volatile market, and I’m shifting my focus .
- The company’s long-term returns appear supportive of this valuation, with the market outperforming annualized RoR even with conservative valuations and expectations. below some EPS analyst forecasts.
- Even the conflicts and macro-economy in Ukraine offer only a few risks to this company – but none are really enough to offset the long-term upside of the company.
- CG is a “BUY” here. A target price that I would consider attractive for an investment based on my goals would be around $55/share – although each investor, of course, should consider their own goals, objectives and strategies. I would also always consult a financial professional before making investment decisions like this.
Remember, I’m all about:
- Buy undervalued companies – even if that undervaluation is slight and not incredibly massive – at a discount, allowing them to normalize over time and reap capital gains and dividends in the meantime.
- If the company goes well beyond normalization and enters overvalued, I reap gains and rotate my position to other undervalued stocks, repeating #1.
- If the company does not go into overvaluation but is at fair value, or goes back down to undervaluation, I buy more if time permits.
- I reinvest the proceeds of dividends, labor savings or other cash inflows as specified in point 1.
This company meets many of my investment criteria and is worth watching.
- This company is overall qualitative.
- This company is fundamentally safe/conservative and well managed (in this case for a private equity/investment company).
- This company pays a well-covered dividend.
- This company has a realistic advantage based on earnings growth or multiple expansion/reversion.
Thanks for the reading.