Treasure Chest | Jul 09 2013
By Greg Peel
Macquarie Group’s ((MQG)) earnings were driven primarily by managed infrastructure funds in the lead-up to the GFC with traditional market-related investment banking operations taking a back seat. The credit crunch killed off Macquarie’s infrastructure model for all intents and purposes, forcing the group to refocus on the traditional market broking/trading and advisory model upon which Macquarie Bank was originally founded. With this in mind, the group expanded its global footprint with opportunistic acquisitions of offshore broking/trading operations.
The acquisitions may yet prove money well spent but the failure of financial markets to rebound with any confidence in the years following the GFC has made it a tough market for investment bank performance. As such Macquarie has been forced to cut staff, reduce remuneration and basically watch its once shining halo fade. In the meantime, the group has shifted more towards annuity-based wealth management revenues and even toward the mortgage business – a fundamental commercial bank pursuit. If Macquarie Group were a political party, it has shifted to the Centre.
No more so was this apparent than when Macquarie released its full-year (April-March) profit result in May. The return to risk appetite and investor confidence which began in mid-2012 had analysts expecting an improved earnings result this time, and indeed earnings exceeded expectations. But that was not what sent analyst jaws dropping. The shock came with a substantial increase in dividend payment and guidance to a 60-80% payout range for subsequent distributions. Australia’s leading investment bank was suddenly looking very much like a commercial bank. (Westpac And Macquarie: More Yield)
Analysts were not necessarily convinced such a lofty payout ratio was a good idea given the group’s earnings are still very much beholden to financial market fluctuations, despite a greater annuity-style focus. But a yield-hungry market loved it. So much so that Macquarie’s share price flew suddenly to the moon (see chart below). Only two brokers in the FNArena database dared to recommend MQG as a Buy (or equivalent) post result, and on the share price jump UBS quickly downgraded to Neutral, leaving only Credit Suisse as the optimist.
A database ratio of one Buy and seven Holds has held fast in the interim, even as the great offshore sell-off has corrected much of the initial share price leap. At least until today. Deutsche Bank has now completed a detailed business-by-business valuation reassessment of Macquarie and as a result has substantially increased its twelve-month share price target and upgraded to a Buy rating.
Deutsche’s analysis of Macquarie’s annuity-style business suggests a valuation of $32 per share. When performance fees, surplus capital and corporate increases are added this rises to $43ps, but this would imply a negative value for the market-related activities of the Securities, Capital and Fixed Income, Currencies & Commodities divisions. By applying international peer multiples, Deutsche values these businesses at a net $13ps. Add it all up and we have $56ps, or around 33% upside from the current trading price.
On that basis Deutsche has lifted its target to $56.20, to well above FNArena database consensus. Database consensus now implies a target of $43.93 but consensus ex-Deutsche is $35.90, which gives one an idea of just how far Deutsche Bank has now stuck its neck out. Other brokers have been quiet since the May result and will likely remain quiet until Macquarie’s AGM on July 25, at which management will update FY14 guidance.
On current estimates MQG is showing an FY14 yield of 5.5%, rising to 6.8% in FY15 (April-March). Offshore earnings prevent full franking.
Technical limitations
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