This past Monday, Macquarie Group ((MQBKY.PK), $32) [ASX:MQG] announced that business has been weaker than expected and forecast earnings will be down 25% for the first half of fiscal March 2011 and flat for the year. With the Street expecting 11% growth for the first half and 14% for the year, look for downward revisions along with timeliness downgrades as well.
Macquarie Group is a well managed, global financial services company headquartered in Australia. Since its founding in 1968, MQBKY has grown into a diversified firm of global size, with offices in the US, Canada, Asia, Europe, and Australia.
Accompanying the flat FY2011earnings forecast of $2.92 per share (exchange rate Aus$ 1: USD $0.92), share prices traded down to a 15 month low.
The problem has been weak investment banking fees. Even a gain of 23% in M&A activity could not offset declines in equity and capital markets and a decline in retail brokerage fees. However, Macquarie is not alone. All major investment banks are suffering from the same market slowdown.
Approx 50% of revenues is generated in Australia where Macquarie is #2 in M&A, but is losing market share to #1 Goldman Sacks (GS) and #3 UBS (UBS). Globally, Macquarie ranks 5th in capital market activities.
Based on its potential 24 to 36 months out, and supported by an attractive current yield, share prices continue to offer investors an intriguing avenue for international investment banking exposure.
With a $1.72 annual dividend, the stock should find major support at a 5.5% to 6.0% yield, implying share values of $29 to $32 or about where it currently trading. The dividend is paid semi-annually in Nov and May, and fluctuates based on net income, usually representing a 60% payout ratio. As earnings increase over the next few years, so will the dividend payout.
In addition to the dividend providing share price support, a reasonable PE of 11 would equate to a share price of $32, based on flat FY2011 earnings. Current book value is estimated at $30.50, and share prices are trading at a small premium of less than 5%.
Australia has instituted a mandatory retirement plan for all workers, called “superannuation”. Employers contribute 9% of wages to an individual, privately managed retirement fund, and Macquarie is a leader in managing these private accounts. Superannuation generates $110 bil a year in retirement contributions and the mandatory percentage is expected to rise to 12% by 2020. Macquarie’s assets under management and their corresponding annual fees should continue to grow over time.
Macquarie is a leader in developing international infrastructure capital pools that are funded by its growing asset base. Some pools are publically traded, such as NYSE-listed Macquarie Infrastructure Fund (MIC), and others are closed to clients only. Macquarie captures an annual management fee income stream from the infrastructure pool. Due to higher cash yields, infrastructure funds had been popular among income investors. However, the economic downturn and high leverage has recently decimated some funds. As the public sector continues to seek capital infusion with the sale of assets being a prime target, Macquarie should continue to lead in this potentially lucrative business.
Over the past 10 years, Macquarie has generated an average 21% annual ROE, representing one of the best in the business. However, with weak investment banking markets created by the economic downturn, and due to its large excess capital balance offering little current return, ROE has decline to 10%. While still acceptable, management should regain their footing and rejuvenate ROE as the global economy improves. As ROE increases with better opportunities, so will earnings.
Macquarie has a nice cushion of excess capital. Currently, management has about $2.8 bil to invest in acquisitions. Deploying this capital will allow the company to continue its asset expansion. Recently, Macquarie has been buying assets on the cheap from financial firms looking to downsize or to raise capital. As the financial crisis and the need to unload assets fades, so does the cheap opportunities. Finding above-average returns for their excess capital is becoming more difficult.
Over the longer-term, it will become evident that Macquarie has been more successful than many competitor investment banks in profiting from the financial crisis. While current investment banking and retail investor markets are weak, current share prices provide both income and capital gains opportunity for shareholders who are patient enough to wait for an improvement in global economic growth.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.
Disclosure: Author is long MQBKY.PK since 2008, long MIC since 2008 and long GS since 2010