Diversity Propels Macquarie Group Higher

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This story features MACQUARIE GROUP LIMITED.
For more info SHARE ANALYSIS: MQG
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In FY18 Macquarie Group performed well, again, and brokers agree the business has many levers to engage despite an increasingly challenged environment.

-Business supported by diverse earnings base and expertise in global asset & risk management
-Other income and charges remain a significant driver of the current performance
-Concerns increased by a large reliance on volatile capital market-facing business
 

By Eva Brocklehurst

Macquarie Group ((MQG)) surpassed its own guidance in FY18, for the sixth year in a row, as brokers suggest the diversified financial business continues a long-held practice of under-promising and over-delivering.

UBS considers Macquarie as a leveraged play, based on growth in assets under management and higher performance fees, market movements and activity, operating leverage and the Australian dollar.

The broker believes the market will continue to be attracted to the infrastructure management business as well as the operating leverage, and this provides upside that is not considered fully reflected in the share price.

Morgan Stanley envisages more upside than downside risk to FY19 earnings and this is expected to support the share price in the near term. Nevertheless, a P/E ratio of around 14x at this point in the cycle means an Equal-weight rating is the go.

Growth in the net profit contribution from the operating businesses is calculated at around 6% per annum over the past three years but management has not provided guidance for FY19. Morgan Stanley forecasts an ongoing improvement in the contribution from capital markets but a modest decline in annuity-style earnings for the first time since the financial crisis.

Main upside risks include performance fees, infrastructure, gains on sales, the group's compensation ratio and a weaker Australian dollar. Risks on the downside are commodities and global market trading income, and impairments.

Bell Potter, too, remains comfortable with the business, supported by the unmatched expertise in global asset and risk management, as well as the ability to adapt to changing market conditions. The broker not one of the eight stockbrokers monitored daily on the FNArena database, retains a Hold rating with a $116.50 target.

While there can be some debate about the quality of the earnings, Ord Minnett concedes the group continues to perform well and demonstrate resilience as well as a balance between annuity and market-facing businesses. Nevertheless, the stock appears fair value.

Notwithstanding some compositional weakness, Credit Suisse believes the results should be positively received, given the solid headline, and raises its target to $115 from $110, maintaining an Outperform rating. The main risks include a downturn in capital market activities and the emergence of a risk-off environment.

Morgan Stanley suggests lumpy items will remain elevated and gains on sale will be the main cause. An increase in equity investments to around $6.8bn should provide a healthy pipeline for gains on sales.

If the operating environment remains supportive and company-specific tailwinds continue to drive an upgrade cycle, then Morgan Stanley suggests Macquarie Group could trade towards its bull case of $125 per share.

Performance Fees

FY18 results benefitted from very strong performance fees, at $595m, primarily in the first half. Performance fees during FY19 are likely to be sharply lower, hence growth may be more marginal than FY18 levels, but from FY20 onwards UBS expects a bounce, as many of the listed funds reach maturity.

CLSA points out the balance sheet carries significant principle infrastructure investments to seed new funds and this aspect of Macquarie's business is 80% unlisted, while the accounting treatment involves recognition of performance fees back-ended a decade after funds were established. This creates a tail of performance fees which will emerge in coming years.

Infrastructure & Energy Markets

While investors have traditionally viewed Macquarie Group as an investment bank, Morgan Stanley estimates that less than 40% of revenue is sourced from traditional investment banking, funds management and wealth management activities that are exposed to equity and fixed income markets.

Meanwhile, Macquarie Group has established a track record in global expertise in infrastructure and energy markets, including renewables, and is positioned to benefit from structural growth, particularly in Asia.

UBS envisages upside in this area in coming years, provided market conditions remain buoyant. Many of the infrastructure funds were established in the years following the financial crisis with assets that were purchased at attractive levels.

With a dearth of investment opportunities across Australian financials, the broker expects the market to continue supporting Macquarie Group despite its price performance.

Ord Minnett had been hesitant about the outlook for recurring growth as the first half results showed no net flows in investment management, a flat asset finance portfolio and a declining principal finance portfolio.

While these trends have continued, the elevated level of activity in infrastructure and real assets and the mortgage growth in banking and financial services have overshadowed.

Morgans agrees the result highlights the strength of the diversified model, although other income and charges remain a significant driver of the current performance, and also lifts its target to $115.

While the broker expects the market will accept other income and charges as being a normal part of the business, the sustainability of these items in future is still questionable. Concerns are arguably increased by a larger reliance on capital market-facing businesses in the current result, as all these operations can be volatile.

Other positives include a strong underlying momentum in banking and financial services driven by the growth in Australian mortgages and funds on platform, which both rose 14% over the year.

CLSA notes scope for additional capital management which could continue as infrastructure seed assets and principal investments are realised. The broker, not one of the eight monitored daily on the database, retains a Buy rating and raises its target to $130 from $117.

FNArena's database shows three Buy ratings, three Hold and one Sell (Citi, yet to comment fully on the result). The consensus target is $105.26, suggesting -4.7% downside to the last share price. Targets range from $79.50 (Citi) to $117 (UBS). The dividend yield on FY19 and FY20 forecasts is 4.9% and 5.2% respectively.

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