• Tue. Nov 29th, 2022

Broadmark Realty Stock: Reasonable Valuation, But Not Convinced

ByElla E. Kidwell

Oct 16, 2022

mycan/iStock via Getty Images

Investment thesis

In our first report of 12e October 2021, we have concluded that Broadmark (NYSE: BRMK) did not deserve a buy rating at $10.02 per share, but if the stock price drops below the asset value, this could represent a good entry point. Now, after a 49% correction in the share price to $5.11, we are re-examining BRMK, considering a recessionary scenario to see if it presents a good entry point.

BRMK looks extremely attractive given its book value, but we think that’s not a good enough reason to invest. Although we like the stock story, we believe that BRMK will not be able to effectively deploy its capital in the current macroeconomic scenario. Since these assets will not be able to generate any cash flow, the discount to book value may be warranted and would not merit a buy rating at this time.

Viability of the dividend policy

Our analysis of BRMK’s dividend policy shows that it is unsustainable and a dividend cut is being considered.

As shown in the table below, the dividend payout has consistently exceeded one for the past ten quarters, with the dividend to FCF even exceeding two on some occasions.

In the first half of 2022, they have already paid $0.42 per share in dividends, or 31.25% more than their distributable income per share of $0.32.

So, with loan portfolio growth slowing (which we expect to slow further due to macroeconomic factors and coverage ratios consistently below one), we believe it is only a matter of time to see a consistent cut in dividends.

BMRK Dividend Chart by Moat Investing and Antonio Velardo

Moat Invest

Asset value

Using the asset pricing model, we calculated the value of Broadmark’s assets after some adjustments.

We wanted to assess where BRMK stands in terms of asset value without any type of intangible assets. For this purpose, we have deducted all goodwill. We have also deducted the right-of-use assets since they are related to leases and, to be on the safe side, we only wanted to assess the value of the assets held.

Given the macroeconomic situation, we believe that a short-term recession is in sight. To take this into account, we made an adjustment to mortgages by reducing them by 30%.

The table below shows these adjustments. This gives us a valuation of $5.26, just 3.9% lower than the current market value of $5.47.

Using the asset pricing model, we calculated the value of Broadmark’s assets after some adjustments.

We wanted to assess where BRMK stands in terms of asset value without any intangible assets, so we deducted all of the goodwill for this purpose. We have also deducted the rights of use of the assets since they are linked to leases and, out of prudence, we only wanted to assess the value of the assets held.

Given the macroeconomic situation, we believe that a short-term recession is in sight. To take this into account, we have adjusted mortgages by reducing them by 30%.

The table below shows these adjustments. This gives us a valuation of $5.26, just 3.9% lower than the current market value of $5.47.

Asset Value Calculations by Moat Investing and Antonio Velardo

Moat Invest

The table below shows how BRMK’s stock prices have performed relative to tangible book value per share at the closing dates for the past ten quarters. We can see that the tangible book values ​​provided a positive deviation for the stock price. Still, on the latest earnings call, management provided an update on its strategy in the current environment. “Part of the change in strategy will be that there may be times when we determine that exiting a defaulted loan or foreclosed property with a principal loss and reinvesting that capital into income-generating loans is the result Ultimately, the goal is to generate strong cash flow and earnings, so we will use this strategy as part of our efforts to maximize performance,” the company said.

Another shift in strategy comes from their launch of mezzanine loans, which are inherently riskier than those Broadmark previously deployed. As we have already explained, they would struggle to deploy their capital efficiently, so to compensate for this, BRMK is now turning its attention to the riskier class of loans.

While management hints at its willingness to take a loss on principal value and its launch of mezzanine loans, no one knows how big those adjustments will be going forward. Yet the market is now discounting the loan portfolio by 30%, as seen in the asset value section. Thus, a discount on current book values ​​is not very surprising, and this positive historical difference between tangible book values ​​and market prices does not seem to hold.

Table of Property, Plant and Equipment / Stock - Closing Price by Moat Investing and Antonio Velardo

Moat Invest

Actual Earnings Model

We calculated actual earnings using the 30% stress factor for our mortgage portfolio.

We have assumed that there will be $32 million of new mortgages rolled out for which BRMK charges an upfront fee plus interest payments which we assume to be 14%.

On the remaining portfolio, we assume that BRMK will earn 10.9% interest, giving us a total annual income of $77.51 million.

With the expected increase in foreclosed assets and the slowdown in the real estate market, BRMK will incur additional costs in managing these properties, which squeezes margins. Taking these into account, we assume an operating margin of 60%.

Using a WACC of 8.5% and adjusting the net financial position, we get real earnings per share of $3.45.

In companies like BRMK, the value of assets is usually greater than the value of earnings due to inherent efficiency issues, such as the inability to deploy all capital at once.

Real Income Model by Moat Investing and Antonio Velardo

Moat Invest

Scenario analysis

We performed a scenario analysis on the main value driver affecting our valuation, ie the mortgage adjustment.

The table below helps us understand how BRMK’s asset value per share and actual earnings per share behave under different stress scenarios.

Script Summary by Moat Investing and Antonio Velardo

Moat Invest

Conclusion

Even with all the adjustments, the asset value is just below the stock price. Yet BRMK will not be able to allocate its capital efficiently in the current macro environment of high interest rates, which has made mortgages expensive. Since these assets will not be able to generate cash flows, discounting to current book values ​​is warranted.

We believe the discount to book values ​​will increase further as they initiate mezzanine loans, and riskier future cash flows are not fully priced in the market.

Dividend policy needs to be changed to make them more sustainable; a dividend cut is on the cards in my opinion.

Therefore, we will always assign a holding rating and wait for the catalyst in the form of a dividend cut or improvement in the construction loan market before reconsidering our position.