Tactical Moves Spark Bright Future Despite Short-Term Challenges

Key Takeaways

• Acquisition of Global Atlantic and a focus on expense management signal potential for more stable, recurring revenue and improved operational efficiency.
  
• Emphasis on strategic investments and an aggressive deployment strategy indicate future growth in management fees, enhancing shareholder returns and earnings per share.
  
• Near-term yields and insurance operating earnings may suffer due to high cash holdings, a slow shift to higher-yielding investments, and reliance on volatile markets.

Catalysts

A private equity and real estate investment firm specializing in direct and fund of fund investments.

• The acquisition of Global Atlantic has expanded KKR's insurance operating earnings, signaling potential growth in more stable, recurring revenue streams which should positively impact net margins.
  
• Introduction of a new financial metric, total operating earnings, aims to highlight the recurring portion of earnings. This is expected to approximate 70% of pretax earnings over time, which would stabilize and possibly increase the overall earnings quality.
  
• Strategic investments through the Strategic Holdings segment, specifically in long-duration private equity strategies, are anticipated to become more regular dividend payers, potentially enhancing shareholder returns and boosting earnings per share in the long term.
  
• KKR's focus on expense management and the revised compensation ratios aim to deliver more fee-related earnings (FRE) to shareholders, indicating an operational efficiency that could expand net margins.
  
• The aggressive deployment strategy, underscored by a healthy pipeline of new projects and an active fundraising pipeline, suggests robust future growth in management fees, directly contributing to revenue enhancement.

Assumptions

• Analysts are assuming KKR's revenue will decrease by -35.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 14.5% today to 91.2% in 3 years time.
• Analysts expect earnings to reach $6.4 billion (and earnings per share of $7.07) by about September 2027, up from $3.9 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $4.4 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 25.9x on those 2027 earnings, down from 26.7x today. This future PE is greater than the current PE for the US Capital Markets industry at 20.6x.
• Analysts expect the number of shares outstanding to grow by 3.47% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.43%, as per the Simply Wall St company report.

Risks

• Elevated cash and liquid asset holdings due to sizable recent transactions could impact the immediate returns on Global Atlantic's portfolio, potentially weighing on near-term yields and insurance operating earnings.
  
• The transition to higher-yielding investments in the insurance segment is expected to take 12-18 months, which may temporarily dilute ROEs and impact overall profitability.
  
• A focus on core plus real estate and infrastructure investments offers attractive long-term ROEs but contributes to modest near-term yields, affecting insurance operating earnings in the short term.
  
• The planned growth in Strategic Holdings' operating earnings to over $1 billion by 2030 relies on dividend activity and portfolio maturity, introducing risks tied to market volatility and investment performance that could impact earnings projections.
  
• The Capital Markets business's future performance is highly dependent on deployment and monetization activity levels, which could be influenced by macroeconomic factors and market conditions, thereby affecting revenue and net margins if there is a downturn in deal flow or investment realization opportunities.

Valuation

• The analysts have a consensus price target of $136.77 for KKR based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $159.0, and the most bearish reporting a price target of just $102.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.0 billion, earnings will come to $6.4 billion, and it would be trading on a PE ratio of 25.9x, assuming you use a discount rate of 7.4%.
• Given the current share price of $116.24, the analyst's price target of $136.77 is 15.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.