Macquarie Group Likes Markets In Turmoil

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

-Positive aspects of volatility to prevail
-Relief from concerns over exposures
-FY16 considered more challenging
-Stock's valuation not overly stretched, analysts find
 

By Eva Brocklehurst

More volatile commodity prices means more clients seeking hedging, which means more trading revenues for Macquarie Group ((MQG)). The investment bank has firmed up FY15 guidance to 10-20% growth compared with prior guidance which mentioned earnings being "slightly up on FY14".

Fixed income, commodity and currency (FICC) trading revenue and a stronger US dollar have contributed to the upgrade and Citi increases its earnings estimates by 2.3% for FY15 and 10.9% for FY16. Unlike during prior periods of commodity price volatility, Citi suspects this time the unsettled market will persist longer, into FY16. The broker continues to observe momentum in M&A deal completions and an increase in the value of the M&As, a positive for Macquarie.

The new guidance range does not include any abnormal performance fees from the Macquarie European Infrastructure Fund 1 (MEIF-1) in the second half. With a sale agreement evident for only one of the remaining three assets, Citi moves two thirds of its remaining MEIF 1 performance fee forecast into the first half of FY16.

JP Morgan had expected Macquarie would have to balance the positive aspects of FX and market volatility with the risk of higher FICC impairment charges. The update confirms the positive aspects but eliminates the near-term risk from the latter. Impairment charges remain a longer term concern in the event of further commodity price weakness. JP Morgan observes a strong share price reaction to the stronger guidance, likely emanating from the unwinding of weakness seen over recent weeks and relief from concerns that were building over the health of the bank's resource related equity and lending exposures.

With Macquarie's $400m resource equity portfolio having taken around $200m in impairments since FY14, JP Morgan's focus has been on the related $2.5bn lending book. The broker suspects the hedging profile of borrowing corporates has protected profitability, but the risk remains if commodity prices fall further and as hedges roll off. The broker highlights the bank's conservative estimate of MEIF 1 performance fees for the remaining assets, taken at the first half result. The aggregate of around $550m in FY15 performance fees signals a challenging task for earnings in FY16, when JP Morgan forecasts double digit underlying earnings growth will contrast with flat headline growth.

Goldman Sachs also considers the update will resolve concerns around exposure to recent commodity market volatility, particularly as the client business appears to have more than offset any risks. The broker considers the stock's valuation is fair, given a business that is expected to deliver a sustainable return of around 14% and pay partly franked dividends of $3.18 over the next 12 months. Goldman Sachs retains a Neutral rating.

The energy trading business and metals and agriculture segments are likely to deliver strong results, as UBS notes the update was based on numbers through to the end of December and the March quarter is the seasonally stronger. Moreover, ongoing falls in bond yields and increasing volatility will be supportive so the broker upgrades Macquarie Group to Buy from Neutral. UBS highlights the fact that Macquarie is highly leveraged to the falling Australian dollar, given around 70% of its revenue is generated outside of Australia. As a result a 10% reduction in the local currency's value leads to around a 7.0% increase in earnings with translation benefits.

Morgans also upgrades the stock, to Add from Hold. The broker considers Macquarie offers strong leverage to financial markets, rebounding corporate activity and Australian dollar weakness, all the while offering a 5.0% dividend yield. The bank is also traditionally conservative when it comes to its outlook. Hence, Morgans believes the weakening Australian dollar and ongoing volatility puts the earnings risk to the upside. Trading on 12.3 times the broker's upgraded FY16 earnings forecast and 1.5 times book value, the stock's valuation is not considered overly stretched. Another positive for Morgans is that the improved guidance does not appear to be driven by lumpy performance fees.

On FNArena's database there are four Buy ratings and three Hold. The consensus target price is $62.48, suggesting 7.3% upside to the last share price, and compares with $61.97 ahead of the update. Targets range from $57.00 (UBS) to $68.00 (Credit Suisse). The consensus dividend yield on FY15 and FY16 forecasts is 5.3% and 5.7% respectively.

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