Macquarie Rakes In Higher Fees

This story features MACQUARIE GROUP LIMITED. For more info SHARE ANALYSIS: MQG

-Mixed outlook prevails
-Further upside in fees
-Tail wind from lower AUD
 

By Eva Brocklehurst

Macquarie Group ((MQG)) will crystallise significant performance fees in FY15, leading to an upgrade to guidance. The financial conglomerate has guided to FY15 being "slightly up on FY14" after previously signalling earnings would be "broadly in line". Moreover, first half results – when the fees will be accounted – are likely to be 25-30% higher than the prior corresponding half, while second half earnings will only be modestly higher than the first half.

Despite confirmation of higher performance fees, JP Morgan believes subdued market volatility will be an obstacle to securities and Fixed Income, Currency and Commodity (FICC) trading revenue, capping the uplift from not just higher fees but also deal activity and growth in domestic mortgages. UBS envisages further upside from higher performance fees and, following a share price pullback, views the stock as more attractive. However, should the financial system inquiry recommend higher capital levels, there may be pressure on Macquarie to strengthen capital ratios, given its surplus has been run down. Both brokers err on the side of caution and retain Neutral ratings.

Most brokers believe the increase in performance fees primarily relates to the Macquarie European Infrastructure Fund 1 (MEIF-1). This unlisted fund is in its asset realisation phase as it reaches maturity. In recent months the fund has sold down stakes in APRR – French toll roads – and Arlanda Express – Stockholm airport connection. From an accounting perspective, Macquarie can now reliably measure the fund valuation and book performance fees. As the rest of this portfolio is sold down over the next 18 months further performance fees are highly likely. UBS would not be surprised to find the performance fees from the fund settle in the hundreds of millions of dollars, given the rally in bonds over the life of the fund and strong underlying asset performances.

Outside of performance fees there were were no changes to forecasts for other businesses and UBS expects another cold North American winter may be required for FICC income to repeat its stellar performance at the end of FY14.  Credit Suisse also observes Macquarie's earnings in recent years have been seasonally higher in the second half, reflecting the FICC leverage to the northern winter through the energy trading business as well as through asset realisations in metals and energy.

The residual MEIF-1 and other unlisted funds approaching their 10-year life should underpin the stronger trend in performance fees, in Credit Suisse's view. The broker makes the point that performance fees are not "one-off". Performance fees have been reported by Macquarie every half year for the last 12 years. The issue is whether they are bigger than usual.  Many of the Macquarie unlisted specialist funds are 10-year closed-end funds, although the broker understands that few have reached maturity and been wound up – the trigger for performance fees. Credit Suisse observes that Macquarie's fee structures and fund performance measures are quite opaque. The broker is also challenged in quantifying what the company's guidance actually means. Historically, the guidance statements are very broadly interpreted by the company with result variations of 10% still considered to be "broadly in line".

The upgrade to guidance is well and good, but Deutsche Bank sticks with a Hold rating and believes the stock is unlikely to re-rate until market conditions turn around. The broker's forecasts prior to the update already reflected the additional contribution from MEIF-1 and assumed some market recovery. Performance fees aside, transaction volumes are soft and continue to affect the market-leveraged franchises, in the broker's view.

For BA-Merrill Lynch the message from the guidance upgrade is that the business can more than offset the FY14 gain from the Sydney Airport ((SYD)) distribution. Rather than focusing on soft transaction volumes, Merrills considers capital markets momentum has been strong and this should extend well beyond the 10% impact from higher advisory revenue. Hence, scope for asset realisations and performance fees rises significantly. The broker believes the expectation for second half profit to be only moderately above the first half is based on conservative assumptions for FICC income and retains a Buy rating. Merrills also notes the fall in the Australian dollar will deliver a tailwind for Macquarie, given its significant offshore exposure. The broker calculates that every 10% fall in the currency it delivers a 7% impetus to Macquarie's earnings.

Macquarie attracts three Buy ratings and four Hold on the FNArena database. The consensus target price is $60.48, suggesting 2.8% upside to the last share price. Targets range from $54.52 (JP Morgan) to $65.85 (BA-ML). The dividend yield on FY15 forecasts is 5.1% and FY16 is 5.8%. 
 

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