Is Value Emerging In Macquarie Group?

This story features MACQUARIE GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MQG

Macquarie Group is taking its usual conservative view with regard to guidance, yet brokers pounce on the expectation of stronger performance fees in the first half.

-Estimates upgraded to reflect stronger performance fees
-Value emerging, with upside from operating leverage?
-Cost reductions key to the medium-term outlook
 

By Eva Brocklehurst

Macquarie Group ((MQG)) is taking its usual conservative view with regard to guidance, indicating FY18 should be "broadly in line" with FY17. Yet, stronger performance fees are also flagged for the first half and these are expected to be in line with the prior half. Macquarie Group has historically produced a stronger second half because of seasonality in its energy business and Macquarie Capital.

This stronger first half outcome could be linked to timing, but Bell Potter suspects the real reason is largely about improved incremental realisation rates as the fund pipeline matures. The broker highlights that past performance fees were sourced from only around 10% of funds that were set up around 10 years ago, and the strike rate can only get better.

Deutsche Bank envisages a stronger outlook, driven by the commentary regarding higher performance fees. The broker upgrades FY18 forecasts by 3% which implies FY18 profit growth of 6%. That said, performance fees are notably volatile and arguably non-recurring. Deutsche Bank cities the 63% reduction year-on-year in performance fees in FY17.

They are also non-recurring, in that they depend in part on profitable asset realisations in each period, despite being an integral part of the company's asset management division. Deutsche Bank also notes, with almost two thirds of revenue sourced offshore, any further strengthening in the Australian dollar from current levels would present a headwind to guidance.

Morgan Stanley agrees FY18 guidance looks increasingly conservative and the seasonality, with a skew to the second half, reinforces the point. The broker now forecasts around 6% growth in FY18 but notes commentary remains subdued regarding the two largest "annuity-style" divisions: asset management and corporate & asset finance.

Morgan Stanley suspects it will be challenging to repeat FY17's $1.4bn of lumpy items but upgrades FY18 estimates to $1.2bn to reflect the stronger performance fees. The broker targets $456m in performance fees in FY18, up from $264m in FY17, but well below the record levels of $700m in FY15/FY16.

Value?

Bell Potter considers the stock a long-term cash and growth story, with a strong balance sheet, funding and capital adequacy. The long-term value lies in the unique position the business holds as a global asset and risk manager, as well as an ability to adapt to changing market conditions.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, maintains and $100 price target and Buy rating. The broker considers the stock a low risk and high return on investment proposition which deserves to trade at a higher global asset manager price multiple.

Goldman Sachs, also not one of the eight, increases forecasts for earnings per share by 1.1% in FY18, underpinned by the better performance fees and partially offset by lower M&A income because of subdued market conditions.

The broker now forecasts 5% net profit growth in FY18. While value is emerging, particularly compared with other diversified financials under coverage, Goldman still finds better value in the major banks and maintains a Neutral rating. Target is $90.14.

Morgans likes the longer term outlook, given the company's position in niche business areas and a proven management team. While a recent fall in the share price has returned some value to the stock, with a more challenged near-term growth profile the broker does not envisage quite enough upside yet, maintaining a Hold rating.

UBS upgrades to Buy from Neutral, following the pull-back in the share price. While the revenue outlook is subdued, the broker continues to believe there is upside to be had as operating leverage is delivered. At the very least, this provides some protection to shareholders should revenue slow. UBS believes revenue was boosted by substantial private equity-style gains on sales over the last year, which will be difficult to replace.

Cost Initiatives

The broker believes continued cost initiatives that the company has flagged are key to the medium-term outlook. Macquarie Group's cost base of $7.3bn is way out of line with its business mix and scale, UBS asserts. In recent years the cost base has blown out to be the same as National Australia Bank's ((NAB)), in dollar terms.

As the business mix is now skewed to asset management, lending and leasing the broker contends that paying staff on investment banking framework is no longer appropriate. UBS expects the cost-to-income ratio to fall to 67% in FY18, continuing a down trend from 85% in FY12.

The broker estimates every -5% reduction in the cost-to-income ratio provides 16% upside to earnings per share. Cost leverage aside, UBS does not believe Macquarie Group can grow revenue in constant-currency terms unless market conditions are very buoyant.

FNArena's database shows one Buy rating (UBS), five Hold and one Sell (Citi, yet to comment on the update). The consensus target is $89.09, signalling 4.6% upside to the last share price. Targets range from $72 (Citi) to $100 (Credit Suisse, yet to comment on the update).
 

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