Citi analysts William R Katz, Neil Stratton and Steven J Fullerton come away impressed from investor meetings with senior KKR & Co. L.P. (NYSE:KKR) management on 9/24.

Their report highlights factors that could drive KKR & Co. L.P. (NYSE:KKR) shares higher over the next 12 months, even considering that the stock has done well YTD.

Correlation catch-up

The analysts point to KKR’s surprising disconnect with the underlying stock performance of its major portfolio companies. KKR’s stock price has historically maintained a very high degree of correlation – as much as +0.92 – with its major listed portfolio companies such as Dollar General Corp. (NYSE:DG), HCA Holdings Inc (NYSE:HCA), Nielsen Hldg NV (NYSE:NLSN) and NXP Semiconductors NV (NASDAQ:NXPI). This correlation is now surprisingly almost nil, though the underlying companies are performing well.

KKR correlation-catch-up

In the opinion of the analysts, this is an aberration and that a “catch-up trade could be brewing.”

2-correlation-catch-up-graph

Above forecast AUM growth augurs well for ENI

The strong markets and excellent growth in KKR & Co. L.P. (NYSE:KKR)’s AUM are likely to lend an upward bias to the company’s measure of profitability – the ENI, or Economic Net Income. AUM could see a boost from rising allocations to alternatives such as KKR as institutions re-risk, or hunt for alpha.

FRE margins may expand

The analysts see moderation in expense growth and solid expansion in the second and third generation fund mobilizations in the sectors of credit, infrastructure, and other non-U.S. segments. All of these point to a bullish FRE (Fee Related Earnings) outlook.

3-expanding-fre-margins

Quiet retail penetration

A little known fact is that retail had a 15% share in the $19B growth in KKR & Co. L.P. (NYSE:KKR)’s AUM. This could be another factor that could drive incremental performance.

Competitive benefits from regulation

The advent of regulatory restrictions such as Basel 3, Dodd-Frank and other changes are likely to benefit the Alternatives category in general, and KKR in particular, because of their adverse effects on the competition.

KKR’s PTP model

The analysts believe the industry, and KKR & Co. L.P. (NYSE:KKR), would benefit by converting to a C-Corp, but without any taxation changes “we see no near term impetus for change.” Management is firmly in favor of the PTP model, saying “the tax pass-through on carry remains both efficient and undervalued.”

Conclusion

Citi have a Buy rating on KKR and a 12-month price target of $26.

4-recommendation