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Morningstar | Macquarie On Track for an Impressive Fiscal 2019; AUD 130 FVE Unchanged. See Updated Analyst Note from 10 Sep 2018

Narrow-moat Macquarie Group’s brief trading update confirmed our positive view that Australia’s largest global asset manager and investment bank is on track to deliver a strong fiscal 2019 profit close to our forecast of AUD 2.7 billion, or AUD 7.93 per share, implying 7% growth. Despite vague guidance, fiscal 2019 profit will be “broadly in line” with the AUD 2.56 billion profit reported for fiscal 2018. We interpret “broadly in line” to mean plus or minus 10%. Fiscal 2019 consensus profit is AUD 2.75 billion, modestly higher than our forecast. Higher forecast profits and the retail-investor-friendly 70% payout underpin our attractive forecast dividend yield of 4.6% for fiscal 2019 and 4.9% for fiscal 2020. We retain our AUD 130 fair value estimate and our fiscal 2019 forecast 45% franked dividend of AUD 5.60 per share, based on a 70% payout, midrange of the 60%-80% target. At current prices, the stock is undervalued, trading 5% below our valuation.

Fiscal 2019 guidance is unchanged since the AGM in late July. First-half fiscal 2019 results are due Nov. 2, and we project net profit of approximately AUD 1.3 billion. Macquarie confirmed that first-half fiscal 2019 profit is expected to be broadly in line with the AUD 1.25 billion for first-half fiscal 2018. First-half fiscal 2018 included an impressive AUD 537 million in performance fees. Short-term upside is the potential sale of Macquarie’s interest in Quadrant Energy, which has been excluded from the firm’s current outlook.

Macquarie’s five operating groups are performing well, with the most profitable division, Macquarie asset management, the standout. Macquarie securities and banking and financial services performed strongly in fiscal 2018, boosting profits by 45% and 9%, respectively, and we expect impressive performances for fiscal 2019. The firm's long-term commitment to and investment in the renewable sector will accelerate in the next decade, likely producing increasing contributions to group profits.

Our EPS forecasts average 8% per year for the next five years, which is robust but down on the 14% average growth for the previous five years. There is upside risk to our earnings forecasts, but key downside 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 missteps. The group still benefits from robust global investment market conditions and good demand for infrastructure and energy assets.

We like the way Macquarie continues to generate performance fees from its key asset management business. This is a key competitive advantage, with Macquarie reporting a total of AUD 2.5 billion in performance fees during the five years to March 31, 2018, averaging AUD 500 million per year. Macquarie’s average performance fee equates to approximately 0.6% per year of equity under management, or EUM, approximately half the long-term average base fee of 1.10% per year. Macquarie Infrastructure and Real Assets, or MIRA, continues to substantially increase EUM, reporting AUD 102 billion at June 30, 2018, up from AUD 86 billion at March 31, 2018 and AUD 77 billion at March 31, 2017. Unspecified performance fees continue to feature, 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).

In our opinion, investors' search for long-term sustainable yield will continue for several years at least, despite signs that key global interest rates are moving higher off historical lows. Macquarie’s diversified global financial services business is well placed to take advantage of stronger market conditions, whether in funds management, asset finance, capital markets, securities trading, or banking, as well as commodities and financial markets. Short-term guidance is subject to the usual caveats, including end-of-period valuation reviews and completion of key transactions, market conditions, foreign exchange impacts, potential regulatory changes, tax uncertainties, and the geographic composition of income.

We forecast an impressive return on equity of 16% in fiscal 2019 and an annual average of 17% during fiscal 2019-23. Based on our earnings forecasts and an assumed 70% payout, shareholders will benefit from an attractive dividend stream, franked at 45%, for the next five years at least. Across the group, approximately 67% of net operating 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 after tax by approximately 7%. The fall in the AUD/USD exchange rate to 0.71 in early September, down from 0.77 at year-end fiscal 2018 on March 31, is a positive for Macquarie’s Australian-dollar-denominated reported net income. The total income split is: 29% from Europe; 27% from the Americas; 11% from Asia; and 33% from Australia.

The Nov. 30, 2018, retirement of long standing and well-regarded Macquarie Group CEO Nicholas Moore was announced in late July, with the promotion of Shemara Wikramanayake well received. We like the appointment and see no risk to Macquarie’s very successful long-term strategy. Wikramanayake will enhance Macquarie’s focus on the interconnectedness between different business units within the Macquarie Group, with emphasis on the global infrastructure and energy investment sectors.