Softer Outlook Emerging For Macquarie Group

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

-Commodities and markets income downgraded
-Stock retracement in line with global peers
-Positive outlook for Corporate & Asset Finance
 

By Eva Brocklehurst

Macquarie Group ((MQG)) is coming to the end of a three-year period of consistently upgrading its forecasts and the latest update suggests softer aspects to the outlook are emerging.

The company described trading conditions as satisfactory, with annuity business contributing more but capital markets weaker versus the prior comparable period. The investment bank's equity tier 1 ratio was stable at 9.9%. FY16 forecasts were maintained. The main change was the downgrade to estimates for the commodities and financial markets division, where the profit contribution is expected to be lower than FY15.

Credit Suisse downgrades FY16 estimates by 2.0%, noting the recent sell-off in the US credit market is the likely driver of the financial group's first easing in its estimates since early 2013. The company has also highlighted the demands of comparable earnings.

The stock's retracement is in keeping with the downturn in global investment banks, but at 6.0% below the broker's valuation highlights a degree of valuation support. Hence, Credit Suisse maintains an Outperform rating.

Market conditions may remain challenging for some time so UBS reduces earnings forecast by 3.0% for FY16 and 4.0% for FY17. Over recent years Macquarie Group has made improvements in its operating efficiency, with its cost-to-income ratio falling to 70% from 85%. In the broker's view this remains unacceptably high, given the business mix. UBS is encouraged by management's renewed focus on its cost base, believing this offers the largest point of potential upside.

The company has benefited over recent years from a falling Australian dollar, easing central bank rates and rallying equities markets, as well as price inflation in hard assets and commodity price volatility.

UBS suspects all these features have peaked in the first half and, while there are a number of strong businesses in the portfolio, conditions are likely to challenging and performance fees lower. The broker expects the stock to remain volatile, but envisages upside over the medium term as operating leverage offsets revenue headwinds.

Deutsche Bank considers Macquarie Group's performance is admirable compared to other investment banks but accepts the cautious outlook may weigh on the share price for some time. A tilting towards annuity-style revenue should shield the company from the worst of markets, the broker maintains.

Still, the price/earnings ratio over history suggests to Deutsche Bank a de-rating tendency in tough times even as forward estimates fall. Hence, the broker considers it too early to rule in a re-rating.

Deutsche Bank remains impressed with the diversification and balance sheet of both the Macquarie Asset Management and Corporate & Asset Finance segments. Still, the disclosure did signal that the geographic and product emphasis in Macquarie Investment Management will result in net flows and market performance remaining below Australian listed fund managers.

Ord Minnett claims it is easy to blame a lack of growth prospects in the next year for the recent share price decline but the main driver is more likely to be the sharp retreat in global investment banking peer multiples. The broker forecasts limited earnings growth in FY17 but expects the result will be compositionally superior to FY16, with significantly lower performance fees and trading revenues replaced by more highly valued lease income from the AWAS aircraft and Esanda businesses.

Morgan Stanley estimates that AWAS and Esanda will add around 40% to corporate and asset finance division earnings and is positive about the segments trajectory, forecasting 31% profit growth in FY17.

Yet, the broker believes the overall earnings upgrade cycle is definitely at an end and the briefing raised questions about the pace of profit growth in asset management and asset finance, and the outlook for commodities related revenue in FY17. Moreover, the briefing revealed that FX and market movements delivered around 75% of the traditional assets-under-management growth over the past five years.

Morgan Stanley envisages emerging headwinds in four of the operating divisions and retains an Equal-weight rating. Citi, too, was unsurprised that the volatility in financial markets was affecting profitability. The broker assumed FY16 would provide a peak in profits and continues to believe the environment is turning less accommodative for asset values and Macquarie Group's profits.

In summary FNArena's database shows three Buy ratings and three Hold. The consensus target is $75.90, signalling 18.7% upside to the last share price. This compares with $86.00 ahead of the update. Targets range from $65.50 to $85.00. The dividend yield on FY16 and FY17 forecasts is 5.7% and 6.1% respectively.
 

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