Ares Management: potential future growth, but stock at fair value (NYSE: ARES)

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Investment thesis

Management company Ares (NYSE:ARES) can be a solution to protect against high inflation in the long term. Indeed, ARES is an alternative investment manager with most of its revenue coming from the credit and private equity segments. The alternative investment segment is heading for massive growth for the next 4 years with a compound annual growth rate of 12-15%. However, the title is quite valued and may even seem a bit overvalued. That’s why I’m watching ARES closely but not taking a position yet, but risk-taking growth investors might find the current valuation attractive with excellent growth expectations.

business model

Ares Management operates as an alternative asset manager in the United States, Europe and Asia. The company consists of 3 main segments: credit group, private equity group and real estate group. The Credit Group segment provides financing solutions to small and medium-sized businesses, the Private Equity Group segment focuses on undercapitalized businesses, and the Real Estate Group segment invests in new developments. The company has approximately $282 billion in assets under management with more than 30 offices around the world. Their largest portfolio is the credit segment with 181.2 billion in assets under management as of September 30, 2021. Ares currently manages 15 different strategies under five main groups, including the 3 main segments mentioned above.

Ares Management - assets under management

Investor Presentation

Finances and income

Q3 results

The company recognizes income from 5 streams, but 2 of them take the lion’s share: management fees and the allocation of carried interest. 60% of management fees come from the largest AUM segment, the credit group.

Ares Management - Revenue streams

The graphic is created by the author. All figures are from the company’s third quarter 2021 financial statements.

The company reported strong third quarter results and ARES will announce its fourth quarter results on February 11, 2022, as well as full year 2021 results. On a basis basis, net income attributable to Ares Management per share was $0.49 for the third quarter of 2021 and after-tax realized income was $192.9 million. The EPS estimate was $0.64 per share for the third quarter and the actual results were a little disappointing with $0.62 per share, a shortfall of $0.02. The company raised $20.7 billion in gross new capital with net inflows of $20.4 billion while assets under management as of September 30, 2021 were $282 billion, a whopping 57% increase from compared to the previous year, but the company made several acquisitions which helped inflate the AUM.

Michael Arougheti, CEO and President of Ares, was confident about the results: “Our third quarter results demonstrate our continued strong performance on our key indicators with record levels of assets under management, management fees and fees, all of which have increased by more than 50% on an annual basis.” Over the past 6 months, ARES has made two acquisitions. On July 1, 2021, Ares completed the acquisition of Black Creek Group’s U.S. real estate investment advisory and distribution business. On December 23, 2021, Ares Management also agreed to acquire the PrivateMarketsCo Infrastructure Debt team and the right to provide management services. The company also launched a senior note offering in January 2022 to support debt repayments and fund future growth.

Evaluation

ARES management expects to have a CAGR of 12% and grow the AUM of alternative assets to $12.9 trillion by the end of 2025. This would seem unrealistic at first glance, but according to advisor channel statistics, alternatives are expected to grow by 62% between 2020 and 2025, with the fastest growth in private equity and private debt. This means that ARES investors can calculate with good organic growth potential from the Credit and Private Equity segment. ARES is currently trading at fair value. The company has total assets of $19,934.4 million, total liabilities of $15,295.2 million, and no preferred shares since Q2 2021. This means it has a book value of approximately 1. $75 billion. The book value has been on the rise since 2019 and this trend is expected to continue according to management.

Ares Management Share Price and Book Value
Data by YCharts

ARES also has a low operating expense ratio of only 47.26%, which means management can allocate its resources well. It is much less than its peers. Apollo Global Management, Inc. (APO) has an operating expense ratio of 58.97%, KKR & Co. Inc. (KKR) which has recently specialized in private equity with the majority of its income coming from of the IT segment has an operating expense ratio of 53.92%. Based on the P/E ratio, ARES looks overvalued with a forward non-GAAP P/E ratio of 29.89 compared to the industry median of 11.58. Taking into account the dividend yield, we can see the same and a rather higher than fair valuation. We could have easily bought the stock with a better dividend yield over the past 3 years except for late 2021 and early 2022.

Ares Management Dividend Yield
Data by YCharts

Company specific risks

The investment management business is extremely competitive, with competition based on a variety of factors, including investment performance and fund terms (especially fees). ARES is not in a bad position but must also be prepared for external pressures such as the Rise of passive investment vehicles. This can reduce the profit margin and the overall turnover of the business. Some internal risk factors might be worth looking into.

Poor performance of the company’s funds would lead to lower revenues and operating results, and could harm ARES’ ability to raise capital for future funds. They derive their income mainly from: management fees, which are generally based on the amount of capital committed or invested by the company’s funds; performance income, which is based on the performance of ARES funds; and the returns from investments of the Company’s capital in the funds and other investment vehicles, including SPACs, that they sponsor and manage. The rise of alternative investments, in general, will have a positive impact on a company’s assets under management but the return on these assets will be challenged by rising interest rates as many investors have found alternative assets as the solution to low interest rates in the 2010s. .

The rapid growth of ARES’ business, particularly outside of the United States, may be difficult to sustain and may place significant demands on the administrative, operational and financial resources of the company. Currently, their spend rate is one of the best among its peers, but it can jump from time to time when the company makes acquisitions or creates new funds. The usual trajectory is that in the short term we see a massive increase in costs, but if the new funds are successful within 2-3 years, these costs can be offset by the revenue generated by these new funds.

My opinion on the ARES dividend

Current dividend

The company has been paying consecutive dividends for 7 years and has a 2-year history of consecutive dividend growth. ARES’ forward dividend yield is 2.44% for a quarterly payout of $0.47 per share. It appears that management intends to stabilize the dividend with a more conservative dividend policy and no cuts. Seeking Alpha estimates a dividend increase for the first quarter of 2022 and expects a dividend of $2.36 per share for the full year 2022.

Future sustainability

ARES has a relatively safe dividend with a healthy payout ratio. Seeking Alpha rates its dividend safety for an A-. This security score is mainly due to the sustainable delivery rate. In terms of dividend growth, ARES has recorded a dividend growth of 17.76% over the past 5 years, beating the industry median of 7.78%. For next year, Seeking Alpha estimates an 18% increase, but I calculated with a moderate increase of 8.5%, as estimates show a slowdown to 11% in dividend increases. Management is committed to paying dividends consistently and also has the ability to increase them as well. ARES’ payout ratio is between 60% and 75% and even with an 18% increase in the dividend next year, it will not exceed 80%. I also expect the dividend increase to occur in the first quarter of 2022, as management typically declares the increase in the first quarter.

Ares Management Payout Ratio

The table is created by the author. All figures are taken from the company’s financial statements and SA earnings estimates.

Summary

Income investors who want to hedge inflation ARES might be a fair choice over the long term, but the company is currently a better opportunity for growth investors who are willing to buy at a fair valuation. Management can reasonably expect assets under management to grow by 12-15% per year in the coming years in the credit and private equity segment. ARES has a stable dividend with room for increase in 2022 and I expect the company to announce a dividend increase in February. I’m watching ARES closely and looking forward to Q4 earnings, but due to the current valuation, I’m not buying at this time.


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