Buying the Barbarians

 | Jun 13, 2013 | 1:00 PM EDT
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Despite once being an infamous name on Wall Street, Kohlberg Kravis Roberts (KKR) certainly does not get much analyst coverage these days. The private equity firm gained notoriety as being one of the core objects of focus for the early 90s book and subsequent movie, Barbarians at the Gate. For barbarians, the firm sure does not make the same waves that it used to -- nor does it seem to be the focus for much investment analysis. This is a shame, as KKR is selling at a low valuation and has a nice dividend yield to boot.

KKR only came to my attention the other day due to the large insider purchases ( about $1.8 million) by Robert Scully, one of its directors. Scully is a long-time Wall Street executive and insider, so when he makes a large purchase, it is worth investigating. This0 was the first insider purchase at the firm since February 2012 -- the stock has run up about 65% over the last year.

A couple of things stand out when one looks at the stock's basic valuation. It is trading at about 9x trailing earnings, which appears cheap. Plus, analysts expect around 40% revenue growth from the company in fiscal 2013. Another item that stands out is the stock's dividend yield and the company's payout policy. KKR does not distribute the same payout every quarter like most companies. The payout can vary significantly from quarter to quarter. However, the yearly payout has shown nice growth over the past few years. KKR paid out a total of $0.71 a share in fiscal 2011, $0.84 a share in fiscal 2012 and has already paid out $0.97 in two payouts in 2013. It seems like a safe bet that the company's total payouts in 2013 will provide a yield of over 6% at the KKR's current price.

The other thing that caught my eye is how off the consensus quarterly earnings estimates seem to be on a regular basis. (Note: The company reports earnings as "economic net income.") I believe analysts have consistently missed how big an impact recovering financial markets over the last few years have on KKR's earnings power. KKR has easily beat consensus earnings estimates for five straight quarters. Most of the beats have been by substantial amounts (see the chart below).

Kohlberg Kravis Roberts (KKR) Quarterly Earnings

The Street seems slow factoring in the improvements in private equity valuations into their estimates for KKR. The company has some about $50 billion of carry-earning AUM. Of this, about 40 billion has no hurdle. These funds are usually invested over long periods. In the first few years, KKR collects a management fee. As these investments are sold or "harvested," KKR collects 20% of the profits. This is a substantial stream of revenue that will accrue to KKR over the next few years -- as long as the financial markets remain solid. In late April the company provided commentary that it had already "harvested" profits equating to $0.18 a share so far for the second quarter.

KKR is currently selling for about $19.25 a share. At that price, investors can pick up an over 6% yield for an equity with a fairly cheap valuation, good growth prospects and some recent significant insider buying.

I have to agree with the analyst from Citi who recently raised the price target to $26 a share on KKR. That would appear to be a more reasonable valuation for these barbarians.

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