Macquarie Group: Too Good To Fail?

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

As the Australian banking industry slowly implodes, investment banking conglomerate Macquarie Group offers an oasis of ongoing earnings growth.

-Six years of consecutive guidance beats
-Diversification of earnings growth sources
-A rare bright light in the banking sector

By Greg Peel

“Great companies under-promise and out-deliver,” said CLSA bank analyst Brain Johnson in a note assessing Macquarie Group’s ((MQG)) FY18 earnings result, delivered early this month. Indeed, Macquarie has turned upside surprises into an art form.

It was over a decade ago that Johnson, then at JP Morgan, famously valued Macquarie as an investment bank at in excess of $100 when consensus targets were much, much lower. Johnson’s previous employer was a little shop called Macquarie Bank. The share price did indeed climb towards the $100 mark in 2007 but along came a thing called the GFC.

Macquarie bottomed under $17 in 2009 and in January this year finally exceeded $100, but not before another difficult period for investment banks in 2011-12 around the time the EU was threatening to implode. Those two years were the only two in the past twelve that Macquarie has not exceeded initial earnings guidance set at each AGM. Guidance has been exceeded every year in the past six.

Prior to Keating’s recession, Macquarie made its mark as a proprietary trading house. When market volatility evaporated in the early nineties the bank switched focus to infrastructure and other bond proxy-style funds – a move which worked extremely well until the credit crunch which preceded the GFC. A further remodelling was required under the new CEO.

While today’s Macquarie Group remains active in capital markets, annuity-style businesses now account for some 60% of income and 70% of profit, Bell Potter notes. While the group has also moved into commercial banking activities – deposits and mortgages – the distinction between Macquarie and Australia’s Big Four could not be more stark.

For one, Macquarie is a global operation, cross-divisionally leveraged, Johnson notes, to everything from non-conventional monetary policy (QE, low rates) to public-private infrastructure stimulus. The Macquarie Infrastructure & Real Assets division currently has $14.8bn in cash ready to be deployed while boasting a long tail of future performance fees as funds initiated up to ten years ago mature.

The Banking & Financial Services Division holds $5.1bn in deposits in excess of loans which, when deployed, increases the bank’s net interest margin.

The traditional capital markets divisions are currently benefitting from increased market volatility.

The group carries a sufficient tier one capital surplus that the regulator, having last year set increased “too big to fail” capital requirements on all the major banks, has approved a $1bn share buyback that Macquarie has yet to activate.

To top it off, Trump’s tax cuts will add around 5% to earnings growth and the group is positively leveraged to a weaker Aussie dollar.

Bell Potter claims Macquarie’s unbroken six-year run of guidance beats to be “remarkable” and believe this is largely due to the company’s transformation and exceptional risk management. With the stock now having gone ex-dividend, analyst TS Lim has upgraded Bell Potter’s recommendation to Buy from Hold.

Grudging Acknowledgement

CLSA and Bell Potter are not included in FNArena’s stockbroker database. At the time of Macquarie’s FY18 result release, brokers within that database were in agreement that FY19 offered more in earnings upside risk than downside. In a reversal of the “cry wolf” fable, analysts struggle to accept management’s guidance that FY19 earnings will be “broadly in line” with FY18.

It took the analysts at Citi till the FY18 result to finally capitulate and upgrade Macquarie to Neutral from a prior Sell based on valuation. The broker quietly lifted its target price to $110.15 from $79.50.

Citi joined three other brokers within the database to set Hold (or equivalent) ratings, alongside three Buy. All broker targets now exceed $100 and database consensus has been upgraded to a net $109.85 post-result from $101.19 previously.

Forecasting a total shareholder return (share price plus dividends) in excess of 15% over twelve months, Bell Potter has lifted its target to $125.00 from $116.50.

But the last word goes to Brian Johnson, who no doubt feels some level of déjà vu in setting a $130.00 target and, subsequently, a Buy (High Conviction) rating.

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