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Are Expectations Too High For Macquarie Group?

Australia | Sep 20 2016

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

Macquarie Group has signalled FY17 earnings are likely to be broadly in line with FY16. Brokers are concerned about investors anticipating that guidance will be upgraded.

-Comparison base of FY16 demanding in terms of net revenue items
-Still offers attractive yield and modestly expanding returns on equity
-Gains on sales, better equity and commodity conditions likely boosted first half


By Eva Brocklehurst

Many investors are hoping that Macquarie Group ((MQG)) will upgrade its outlook, having done so with some regularity in the past year or so. Yet, the Group's latest update signalled the first half result is expected to be similar to the second half of FY16, with FY17 guidance for profit to be “broadly in line”.

Citi calculates that with the sale of a stake in Macquarie Atlas ((MQA)) in the first half, Macquarie Group experienced a $150m post-tax gain. This leaves the underlying operating division earnings actually weaker in the half, and means that a lot needs to happen in the second half to meet guidance.

The broker expects earnings to be lower in four of the six divisions in FY17, emphasising that “broadly in line” can also mean “lower” and citing the fact conditions were mixed in the first quarter, with lower performance fees and subdued markets for Macquarie's capital and securities divisions.

Credit Suisse agrees that the business has a job on its hands, noting the comparison base of FY16 is quite demanding in terms of the net revenue items. The broker observes the multi-year earnings upgrade cycle is now quite mature but the stock still offers a reasonably attractive value and yield, with modestly expanding return on equity.

Nevertheless, the stock is cycling demanding comparisons from FY16, when there were commodity trading, operating lease income and principal investment gains to be had. The broker envisages scope still exists for residual positive earnings surprise.

On the positive side, guidance for the first half and FY17 implies a return to the more traditional seasonal skew towards the second half, with the oil & gas business being geared to the northern hemisphere winter and a tendency for principal investment gains to be crystallised in the second half.

This seasonality was not evident in FY16. Another way of viewing the guidance is in the context of the first quarter trading statement at the AGM, at which Macquarie stated that aggregate contribution profit was down on the previous corresponding quarter but up on the sequential quarter.

Guidance is conservative, Deutsche Bank believes. While remarks regarding Macquarie Asset Management were a little softer, and some may have been wishing for an upgrade to be announced, the broker is comfortable in expecting 3% growth in group profit for FY17, given guidance has erred on the side of caution recently. The group no longer provides detailed divisional guidance, providing only qualitative commentary regarding asset management.

While previously higher base fees were expected, Macquarie now expects underlying growth in base fees to offset the impact of divestments. This suggests that base fees are tracking below Morgan Stanley's forecasts, although additional divestments could raise the prospect of higher performance fees.

The broker suspects investors will still be looking for an upgrade to guidance at the first half result in late October. The forecast for profit to be broadly in line in the first half is around 8% ahead of Morgan Stanley's estimates, although not surprising to the broker given the recent decision to sell a stake of around 10% in Macquarie Atlas.

The broker believes gains on sales and better conditions in equity and commodities markets have boosted the first half, and consensus upgrades are required to support the share price. While the broker already assumes that commodity related net gains on sales/write downs improve by $300m this year there is some upside risk still envisaged for trading income.

Upside bias also comes with improving conditions in equity markets. While Morgan Stanley considers the AWAS and Esanda acquisitions add 6-7% to FY17, earnings commentary suggests modest growth.

On FNArena's database there are three Buy, three Hold and one Sell (Citi). The consensus target is $75.95, suggesting 6.6% downside to the last share price. The dividend yield on FY17 and FY18 estimates is 5.0% and 5.3% respectively.

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