Challenges Remain Before Macquarie Is Re-Rated

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This story features MACQUARIE GROUP LIMITED.
For more info SHARE ANALYSIS: MQG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

For most securities analysts covering the stock, Macquarie Group’s ((MQG)) full year underlying profit result was broadly in line with expectations, the higher level of write-downs offset by a number of one-off gains to generate a reported profit of $871 million.

Both UBS and JP Morgan saw the result as reasonable and within expectations, but both remain cautious on the outlook in future years thanks to both a tougher operating environment and increased competition in the “vanilla” style capital offerings the bank had all but perfected in recent years.

According to Credit Suisse, the result and the associated capital raising announced with it means the group’s re-orientation of its funding mix has now largely been completed, leaving it more free to concentrate on generating growth via measures such as increasing market share and incremental acquisitions.

Others were a little more critical, Deutsche Bank not only lowering its estimates post the result but arguing there remains risk of further write-downs and the likelihood of lower returns on capital given factors such as the slower pace of global economic activity.

The broker suggests group staff numbers are a good indicator as in recent years they have tended to move in line with revenue growth rates, so given the bank has been trying to lower its head count of late Deutsche is cautious on Macquarie’s revenue outlook into FY10 in particular. This means earnings will be under pressure and the stockbroker expects the same pressure on the share price.

To reflect this caution, the broker has cut its earnings per share (EPS) forecasts for the bank to 392c in FY10 and to 441c in FY11, which is down from 451c and 497c previously. Bank of America-Merrill Lynch reacted similarly to the result and cut its estimates by 20% and 8% respectively for the next two years, putting its EPS estimates at 293c and 426c in adjusted terms.

By way of contrast, the FNArena database shows consensus EPS estimates for Macquarie Bank of 314.1c and 382.1c, with UBS well below consensus at 207c and 306c respectively.

According to Bank of America-Merrill Lynch, while the bank has been profitable through the global financial crisis there remains further risk to both revenues and costs. At the same time there is little evidence to date of new revenue streams being developed that would drive a return to more impressive rates of earnings growth.

The other issue highlighted by Deutsche Bank is the value of the group’s listed offshoots, as at present the difference between their share prices and the group’s carrying value is a little north of $1 billion in pre-tax terms. The potential this or part of this difference is written down is likely to weigh on the share price in the broker’s view, as is the latest capital raising.

This raising is important in the view of JP Morgan as it suggests while the FY09 result was something of a marker in terms of potentially being the bottom for earnings and showing what the company could expect to generate in terms of underlying revenues in a more difficult market, the minimal level of surplus capital meant there was very little to invest to generate additional revenues.

While the capital raising helps solving this limitation, the broker sees it as a case of asking investors for more capital to invest into uncertain markets today to generate higher returns than are currently being generated. The uncertainty of this is shown by no change to the broker’s Neutral rating, as in its view the group remains in what it classes as the “staying alive” phase of meeting return on equity hurdles.

To reflect the result, Deutsche Bank has downgraded its rating on the stock to Hold from Buy, at the same time dropping its price target to $30.00 from $37.00 previously. Bank of America-Merrill Lynch matched the move in terms of the rating’s downgrade and the FNArena database shows the stock is now rated as Hold Seven times, while only GSJB Were retains a Buy rating.

The average price target according to the database has fallen to $29.37 from $31.20 previously, with Citi the low marker at $24.73 and GSJB Were leading the way with a target of $36.30. Shares in Macquarie today are weaker despite a strong overall market and as at 1.20pm the stock was down $1.19 or 3.6% at $32.29. This compares to a range over the past 12 months of $15.00 to $67.20.

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