Australia | Sep 17 2007
By Greg Peel
This week in the US, four major investment houses will announce their third quarter profits – a proposition which has the world holding its breath. Just what sort of mortgage security losses will be booked by Lehman Bros, Morgan Stanley, Goldman Sachs and Bear Stearns? Their share prices have been largely trashed since Bear Stearns kicked off the credit crunch in July. Current consensus suggests Lehmans will reveal a 6% fall in quarter-on-quarter earnings, Morgan Stanley 14%, and Bear Stearns 41%. The largest and most diversified of the group – Goldmans – is actually expected to show a 33% increase. But given the opacity of the asset-backed securities market, forecasts are far from certain.
So it would stand to reason that Australia’s largest investment bank / broker-dealer /asset originator, Macquarie Bank (MBL), should also be looking at some pretty serious losses. The Millionaires Factory is just way too clever by half. Clearly it’s a house of cards that will crumble in the global liquidity crunch. Obviously it’s Australia’s answer to the Bear Stearns of the world. Didn’t it already announce potential losses of 25% in a couple of hedge funds?
FNArena attended a dinner last month which happened to coincide with the day Macquarie’s shares had traded below $60 – representing a spectacular drop from close to $100 in May. Macquarie CEO Alan Moss attended only briefly, being, as I suggested to him, a “man under siege”. His response was a laugh and an incredulous shake of the head. Just how hard was it going to be to prove to the world the Macquarie model bore little relationship to that of the troubled group of US investment houses?
Last week Macquarie provided a scheduled update of its European operations. It also took the opportunity to announce that first half (April-September) profit would be some 40% more than the previous half. Alan Moss has a history of providing the market with conservative guidance, only to make spectacular upgrades further down the track or blow away analysts with actual profit results. This was not a time to be conservative. This was a time to settle the case once and for all that the Factory was not exposed to the sort of significant losses the market was anticipating.
As UBS summarised it, Macquarie stated it has no unusual trading exposures, no material problem credit exposures, no exposure to structured investment vehicles (SIVs), and no debt underwriting or leveraged loan problems. Its ratio of Tier 1 capital is in excess of 15%. In short, Macquarie puts Australia’s four pillars to shame. Moreover, the bank’s level of assets-held-for-sale is the lowest it has been since 2005 (a significant element of its business model that differs from traditional banks).
As Macquarie’s share price slipped into oblivion last month, bemused analysts could only shake their heads in wonder. Sure – it was easy to see why the market was panicking, given the general level of ignorance and uncertainty surrounding the credit crunch, but 40%? Six out of eight brokers in the FNArena database rate Macquarie a Buy – a ratio unchanged since before the troubles began. Five of the eight are maintaining 12-month target prices over $100, with UBS the high marker at $114. The average is $103.80, some 35% above Friday’s close.
Only GSJB Were (Hold) is less than fundamentally bullish, suggesting that the second half will bring earnings softness and the overall credit situation downside risk. Were’s target sits alone at $85.52. Merrill Lynch (Neutral) has not reported since last month, when the analysts suggested they would like a bit more clarity on Macquarie’s debt position. Nevertheless, Weres also suggested at the time the stock had fallen too far and was a longer term investment opportunity.
The profit update was enough for most analysts to increase their own forecast assumptions, despite the fact that analysts always forecast more then guidance, given management’s history of conservatism. Deutsche stayed put, as did Citi given their forecasts were already top of the market. The Citi analysts were somewhat disappointed in the update, as 1H08 guidance only takes us to the end of this month. What about 2H?
Management offered that the international business pipeline remained “reasonable”. Clearly the sort of activity seen in the past twelve months is not going to be replicated in the short term, but with a strong balance sheet, established debt funding and overall level of expertise and standing as the world’s leading proponent of specialist funds, Macquarie is well placed to take advantage of whatever opportunities arise, including whatever fallout may occur across the globe. And the move to establish a non-operating holding company structure is also a positive as far as analysts are concerned.
As Morgan Stanley’s analysts put it:
“In our view, MBL’s trading update provides further evidence of the difference between MBL’s operating model and that of global investment banks.”