Macquarie Group ((MQG)) has consistently surpassed its own guidance in recent years and FY19 was no different. Now, the company has somewhat unsettled investors by suggesting FY20 outcomes may be more subdued and “slightly down” on FY19.
Macquarie Group delivered 17% growth in earnings in FY19, largely from $2.1bn of investment gains on sale in the second half, a record commodities contribution and strong performance fees. Reported profit was $2.98bn, up 17% and ahead of guidance for growth of around 15%. Revenue rose 19% in the second half, with the FY19 cost-to-income ratio up slightly to 70%.
Ord Minnett found the result heavily reliant on lower-quality items, with gains on sale and performance fees contributing 30% of net operating income in the second half. Given this, the broker is not surprised that the FY20 outlook has disappointed. To obtain the usual “broadly in line” guidance, it may take some effort, with commodities income also likely to fall from record levels.
The result was characterised by a particularly strong performance in markets-facing businesses that grew 76% in terms of net profit and this offset a -4% decline in net profit from annuity-style business.
Citi was disappointed with the annuity-style business. This is despite strong performance fees, strong lending and deposit growth. Still, profits are expected to remain healthy and this business should recover in FY20 to maintain group profits close to the FY19 peak.
Credit Suisse suspects that the underlying business performed better than the headline numbers suggest and there was some conservatism adopted in terms of the timing of fee recognition, as well as impairing assets that only recently had not met performance expectations. The broker asserts that it is only a matter of time before guidance of “broadly in line” is reinstated.
For Morgan Stanley the main issue is whether guidance is conservative or if the record FY19 result is just too hard to repeat. The broker suspects it is the former, given there are several levers for both revenue and costs. There is positive operating momentum across most of the business and Morgan Stanley suggests lower gains on sale and commodities revenue can be absorbed and still meet guidance.
The broker’s analysis suggests earnings would be -6% lower if gains on sale were $1bn (versus $2.1bn in FY19) or if commodities revenue fell another $400m to the FY17/18 average. Morgan Stanley forecasts a -2% decline in earnings to $2.93bn in FY20 and believes post FY20 the business will be in an earnings and returns growth cycle, given unrealised gains across a number of operations, a favourable environment, structural tailwinds and flexibility in the compensation ratio.
Outlook
Taking into account the fact that management is typically conservative, FY20 guidance still appears to be a -7% downgrade to consensus expectations, Morgans points out. The second half dividend was also below the broker’s expectations while the pay-out ratio is at the lower end of management’s target range of 60-80% despite a strong capital position. Morgans expects some flattening in earnings but, after very strong results, this should not be judged too harshly.
UBS describes it as “the afterburner”. The company generated the highest level of gains since FY07 in its investment income (gains on sale), which represents 16.5% of revenue. UBS believes this enabled Macquarie Group to take a conservative view on valuations, with $552m in impairment charges, the highest level since FY09.
However, gains on investments are now more heavily concentrated in developments such as green investments, energy & technology and less weighted towards private equity style investments and co-investment with investment banking clients. Hence, solid gains are expected to continue on investments in FY20 but not at the same scale.
While market conditions are positive, the broker understands why the company is providing a more cautious outlook. The broker remains careful about capitalising the more volatile revenue streams at this stage of the cycle but believes investors will maintain the faith, especially domestic investors with a dearth of alternatives, although the stock is likely to be range bound until momentum is restored.
Morgan Stanley points out Macquarie Group generates two thirds of its revenue outside of Australia and is more positive versus consensus on the near-term outlook for the global economy compared with Australia, favouring companies with global growth options.
MIRA
Ord Minnett downgrades to Hold from Accumulate, given the limited potential upside in the stock. The broker remains positive about the prospects for Macquarie Infrastructure and Real Assets (MIRA) and green energy opportunities for Macquarie Capital, although believes these need to be balanced against the challenges in the principal finance unit and the cycling of tough comparables.
Morgan Stanley notes MIRA is one of the largest global alternative asset managers and should continue to grow base fee revenue, expecting a 6% compound growth rate over FY19-21. This is considered high-quality revenue generated by 10-year closed-ended funds operating in a structurally growing segment, as institutional investors look to increase allocations to real assets.
There are three Buy ratings and four Hold on FNArena’s database for Macquarie Group. The consensus target is $128.39, suggesting 2.0% upside to the last share price. Targets range from $115 (Deutsche Bank) to $136 (Morgan Stanley). The dividend yield on FY20 and FY21 forecasts is 4.6% and 4.7% respectively.
