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Morningstar | Changing of the Guard at Macquarie with Ms Wikramanayake Promoted to CEO. FVE AUD 130 Intact

The news of the retirement of long-standing and well-regarded Macquarie Group CEO Nicholas Moore and promotion of Shemara Wikramanayake overshadowed the brief and in line first-quarter fiscal 2019 trading update. We like the appointment and see no risk to Macquarie's very successful long-term strategy. Ms Wikramanayake is a 30-year Macquarie veteran and has led the most profitable and fastest growing business unit, Macquarie Asset Management, for the past 10 years. Ms Wikramanayake is the first female CEO of a major investment bank and asset manager, demonstrating Macquarie is leading the charge in executive diversity. It is a move we believe will be very much welcomed by the broader investment community.

Our positive view on Australia's largest global asset manager and investment bank is intact and at the current stock price, the stock is fairly valued, trading 6% below our AUD 130 fair value estimate. The positive high-level trading update did not surprise. Narrow-moat Macquarie confirmed the five operating groups are performing in line with expectations. Unspecified first-quarter fiscal 2019 operating earnings are up on the previous corresponding period, or pcp, and the firm's long track record of resilient performance across the five business units continues. Fiscal 2019 guidance for group profit to be "broadly in line" with the AUD 2.56 billion in fiscal 2018 was confirmed.

Our higher-than-guidance fiscal 2019 profit forecast is AUD 2.7 billion and if achieved, will be 6% higher than fiscal 2018. We forecast a solid EPS growth rate of 6.7% for fiscal 2019 following a strong 15.4% increase in fiscal 2018. Our AUD 5.60 per share dividend, 45% franked, is 7% higher than fiscal 2018. Our forecast dividend is based on a 70% payout, midrange of the 60%-80% target. Consensus profit estimates are AUD 2.7 billion and AUD 5.59 per share dividend for fiscal 2019.

Mr Moore retires Nov. 30, 2018 after 10 years as CEO. During his tenure as CEO, net profit after tax increased to AUD 2.56 billion in fiscal 2018 from AUD 971 million in fiscal 2009. Market capitalisation increased to AUD 42 billion from about AUD 14 billion at March 31, 2008. Dividends have increased to AUD 5.25 per share in fiscal 2018 from AUD 1.75 per share in fiscal 2009. Based on Morningstar estimates, total shareholder returns averaged 15% each year for the past 10 years. Whichever way you look at the financial outcomes, Mr Moore's track record is outstanding, with shareholders benefiting, according to Macquarie, “very substantially.”

Looking ahead, we forecast impressive returns on equity around 17% per year and an attractive dividend stream for the next five years at least. Despite our positive long-term view, key risks include weaker capital markets activity, lower profits or losses on asset disposals, increased impairments, nonrepeat of performance fees, and reputational damage from potential management mis-steps. Earnings are down on the seasonally strong March quarter, but the group continues to benefit from robust global investment market conditions and good demand for infrastructure and energy assets. Macquarie's most profitable division, the nonmarket facing business of Macquarie Asset Management continues to perform well with strong, but unspecified base and performance fees featuring.

Macquarie Asset Management's assets under management, or AUM, increased an impressive 8% in the quarter to AUD 534 billion at June 30, 2018, largely due the acquisition of previously announced GLL Real Estate Partners in Germany and ValueInvest, as well as infrastructure asset acquisitions, and favourable market and foreign exchange movements.

Macquarie Infrastructure and Real Assets, or MIRA, increased equity under management an impressive 18%, or AUD 16 billion, to AUD 102 billion during the quarter, well above our March 31, 2019 estimate of AUD 94 billion. MIRA benefited from AUD 5.6 billion in new institutional investment mandates during the quarter and invested AUD 4.8 billion. Based on our estimates, MIRA has AUD 15.6 billion of investment equity to deploy as at June 30, 2018. Unspecified performance fees again featured in the quarter, and we estimate a total of AUD 577 million in performance fees for fiscal 2019 (5.1% of total 2019 estimated revenue) following AUD 595 million in fiscal 2018 (5.4% of total 2018 revenue) and 264 million in fiscal 2017 (2.5% of total 2017 revenue).

Earnings from corporate and asset finance were down on pcp mainly due to the timing of transactions and reduction in the size of the portfolio. Corporate and asset finance's portfolio of AUD 34 billion was broadly stable on March 31, 2018.

As expected, banking and financial services continues to benefit from good growth across mortgages, business banking, investment platforms in the first quarter compared with March 31, 2018. Customer deposit balances were broadly in line with pcp. Australian mortgages grew an impressive 5% on March 31, 2018 to AUD 34 billion as did funds on platforms to AUD 87 billion. Total customer deposits increased 3% in the quarter to AUD 47 billion. Despite strong mortgage growth, Macquarie holds only a 2% share of the Australian market based on Australian Prudential Regulation Authority banking statistics as at May 31, 2018. Macquarie holds about 1% market share of household deposits in Australia.

The capital market facing businesses experienced strong trading conditions across most markets. Commodities and financial markets benefited from stronger activity reflecting increased demand in commodity markets and for fixed income products. Ongoing market volatility in commodities (particularly North American gas markets), foreign exchange and futures markets provided fertile conditions for Macquarie's profit-motivated investment bankers. Underwriting income in cash equity markets was strong, particularly in Asia. Despite good results from Macquarie Capital's balance sheet positions and realisations, debt capital markets activity was lower than the strong pcp. We expect further improvements in global capital markets with Macquarie well placed to leverage its trading and transaction capabilities, particularly in infrastructure and energy sectors.

Capital and funding levels remain strong with the common equity Tier 1 ratio of 10.3% at June 30, 2018 exceeding regulatory minimums. Management's fiscal 2019 guidance is implicit on the usual caveats, being subject to the completion of investment transactions, market conditions, the impact of foreign exchange movements, potential tougher regulatory changes, tax uncertainties, and the geographic composition of income. Pleasingly, there were no significant one-off items in the quarter.