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Morningstar | Macquarie Delivers Another Stellar Performance in FY19, But Can it Last? FVE AUD 135 Unchanged

Narrow-moat Macquarie Group impressed with another stellar operating performance for fiscal 2019. The 17% increase in net profit to AUD 3.0 billion was in line with expectations and modestly above guidance “of up to 15%” increase. Highlights were many, particularly revenue up 17%, market-facing business profits up 76%, performance fees up 29% and equity under management increasing 36% and the impressive return on equity of 18%. The combined profit contribution (before corporate overheads) of the market facing businesses increased to AUD 2.9 billion, at the same time the nonmarket-facing businesses suffered a 4% combined profit decline AUD 3.3 billion.

Despite achieving our profit forecast for fiscal 2019, we reduce our fiscal 2020 profit forecast 6% to AUD 3 billion with smaller reductions in later years due to increasing uncertainty in global investment markets. We now forecast flat EPS for fiscal 2020 and average EPS growth of 6.5% per year for fiscal 2021-25. The modest reduction in forecast earnings offsets the time value of money effect and our fair value estimate of AUD 135 per share is unchanged. At current prices, the stock is fairly valued.

We like the way the diversified and interconnected business model underpins the group’s profitability with the market facing businesses more than offsetting softer profits from the nonmarket-facing businesses. The key to the firm’s long-term success is a strong balance sheet, underpinned by surplus capital, liquidity and funding positions and conservative risk management. Even though the firm has benefited of late from large asset realisations, performance fees and investment income, the underlying businesses also continue to grow. Despite being “one-off” transactions, we are confident these investments can repeat as we have witnessed every year for the past decade. Equity investments fell during the year, but at AUD 5.9 billion at March 2019 there are plenty of opportunities for future asset realisation profits.

Disappointments were few, but the 43% increase in impairments to AUD 522 million and the lower than expected dividend and the modest increase in the cost/income ratio stood out. The final dividend of AUD 3.60 per share took total dividends to AUD 5.75, franked at 45%, well short of our forecast of AUD 6.20 per share. The payout declined to 66% from 70% a year ago, despite surplus capital surging to AUD 6.1 billion from AUD 4.2 billion at March 2018. We reduce our forecast payout to 68% from 70% previously and retain a 45% franking rate for our five year forecast. The group’s dividend payout target is 60-80%.

The fiscal 2019 NPAT was in line with market expectations, but the stock price fell a surprising 6% possibly due to guidance that the fiscal 2020 profit is currently expected to be slightly lower than the AUD 3 billion reported for fiscal 2019. Guidance is subject to the completion of investment transactions, market conditions, the impact of foreign exchange movements, potential regulatory changes, tax uncertainties and geographic composition of income. Despite these uncertainties we are increasingly confident the firm can achieve our medium-term earnings forecasts. We retain our medium uncertainty rating and narrow moat rating.

Macquarie is a global leader in infrastructure asset management and renewable energy and is well placed to generate impressive earnings and dividend growth. We see good long term structural growth opportunities across most of Macquarie’s businesses. We particularly like Macquarie’s long-term commitment and investment in the global renewable energy sector with accelerated investment expected during the next decade, which in our view will boost group profits and shareholder returns. Across the group, approximately 66% of total income is sourced offshore and a 10% average movement in the Australian dollar against all major currencies is estimated to increase/decrease full-year net profit by approximately 7%.

Macquarie’s two market facing business continue to benefit from stronger capital markets activity and client demand with Macquarie Capital printing a 89% increase in earnings to AUD 1.4 billion, the best result since the GFC 11 years ago. Commodities and Global Markets contributed a 65% profit increase to a record AUD 1.5 billion for the year. The combined profit contribution (before overheads) of AUD 2.9 billion represented 47% of group earnings, comfortably higher than the 10-year average of 37%. The non market facing businesses contributed a combined profit of AUD 3.3 billion down 4% on fiscal 2018 representing 53% of group earnings and below the 10-year average contribution of 63%.

The AUD 765 million in performance fees represented 0.75% of equity under management, of simple average in Macquarie Asset Management. The long-term average performance fee to equity under management ratio is 0.5%. Performance fees averaged AUD 524 million per year for the three years to end fiscal 2018 and importantly management is guiding for similar performance fees in fiscal 2020. Equity under management increased 37% to AUD 117 billion due to acquisitions and new equity raised.

Assets under management increased 11% to AUD 551 billion mainly due to increases in Macquarie Infrastructure and Real Assets, or MIRA, managed funds, foreign exchange impacts, acquisitions and positive market movements. Base management fees across the Macquarie Asset Management group averaged 0.33% in fiscal 2019, calculated on the simple average of opening and closing assets under management. Base management fees for MIRA’s equity under management average 1.1% since fiscal 2011.

Key downside risks include a slowdown in the global economic growth, weaker capital markets, lower profits or losses on asset disposals, increased impairments, nonrepeat of performance fees and reputational damage from potential management missteps. The group continues to benefit from robust global investment market conditions and strong demand for infrastructure and energy assets, but a reversal of these tailwinds would likely result in lower profits and shareholder returns.