Macquarie Group Upgrades Guidance, Again

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

-AUD downtrend supportive
-Possible upside on rejigging costs
-Cheap or fully valued?
 

By Eva Brocklehurst

Macquarie Group ((MQG)) has raised its earnings guidance – again. Brokers have suspected for some time the diversified financial group has erred on the side of caution. Weakness in the Australian dollar and improved trading conditions in equities and asset management means a 40% hike in first half earnings is forecast.

Given the second half of the company's financial year – the six months to March – is usually seasonally stronger, offset by fewer performance fees, the company expects a flat outcome. This implies FY16 profit of around $1.9bn.

Macquarie Group has the advantage of around 70% of its earnings being generated outside Australia, with the resultant translation benefits. Few other listed investments in the Australian market provide as much leverage, UBS observes. UBS expects Macquarie group's cost-to-income ratio to fall to 71.5% from 73.9%.

Despite its development into a globally diverse financial institution over the last 20 or more years, the broker observes the  group's cost-to-income ratio has been relatively stable over that time. Macquarie now has more "annuity" style income but still has an investment bank cost structure. Structurally addressing its cost base could provide substantial upside to shareholder returns over the medium term. UBS calculates that every 5.0% reduction in the ratio could add 18% to earnings per share.

Even with a reduction in performance fees in the second half JP Morgan still believes the guidance is conservative, given a traditional 40:60 skew in earnings towards the second half. In particular the fixed income, currencies and commodities trading business has traditionally benefited in the second half from a material increase in volatility. The prospects of a further depreciation of the Australian dollar may again provide a further boosts to earnings.

Goldman Sachs, not one of the eight brokers monitored daily on FNArena's database, now expects FY16 profit of $1.92bn and raises forecasts for FY16 and FY17 by 8.6% and 3.5% respectively. The broker reduces its target to $78.87 from $81.25 as a result of updating multiples on the back of recent market moves. The stock price, trading on around twice net tangible assets, appears to be factoring valuation, in the broker's opinion. Hence, a Neutral rating is maintained.

Credit Suisse is also of the view that the increased volatility in trading markets in the current market is positive for Macquarie, even if primary issuance volumes have pulled back. The broker estimates that just less than half of the expected 40% uplift in the first half could relate to currency translation. The main downside risk for investment banking earnings, that Credit Suisse can foresee, is that improved trading conditions may not persist if the volatility worsens.

Seasonality, which skews the earnings to the second half, derives in Macquarie Group's case from both the energy trading business that is geared to the northern hemisphere winter and equity investment gains which are crystallised in conjunction with the annual cycle of staff profit share arrangements. The broker, therefore, regards second half guidance cautiously and awaits clarity from the actual first half performance fee base.

The announcement supports Morgan Stanley's view that Macquarie Group remains in an earnings upgrade cycle and the business mix and return on equity in the mid teens justifies higher trading multiples. The broker forecasts FY16 profit of around $1.96bn and considers the stock cheap versus the Australian financials as well as the broader market.

In Deutsche Bank's view the momentum is also positive but has been priced into the current share price. Some risks are envisaged in the operating environment stemming from China and the expected lift in US interest rates at the end of this year/early next year. Hence Deutsche Bank prefers a Hold rating.

FNArena's database has four Buy ratings and three Hold. The consensus target is $84.73, which suggests 8.5% upside to the last share price. Macquarie's FY16 and FY17 forecast dividend yield is 4.7% and 4.9% respectively.
 

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