Macquarie Group: Financial Firm Delivers High Dividend and Exposure to U.S. Dollar Decline

May. 3.11 | About: Macquarie Group, (MQBKY)
Macquarie Group (OTCPK:MQBKY) is a multi-national investment and financial firm with headquarters in Australia. While overlooked by most financial sector investors, MQBKY offers an above average yield, substantial dividend growth, and capital gains potential. The decline in the US Dollar over the past six months has richly rewarded investors seeking income in the financial sector.
Macquarie Group offers investment banking, retail and commercial banking, commodities and securities trading, and brokerage services. With strategic acquisitions over the past few years, Macquarie generates 60% of its operating income offshore in Asia (16%), North America (30%) and Europe (14%). The firm carries slightly more than AUD$ 3 billion in excess capital and has AUD$ 5 to $6 billion in excess liquidity it can deploy for future growth initiatives.
Macquarie has a market capitalization of USD $ 13 billion, with 346 million shares outstanding.
Management recently announced FY2011 earnings, and second half earnings rose by 27% over the first six months. However, similar to its investment banking peers, full year earnings declined.
While US financial firms struggle with either reinstating their dividends or increasing distributions, Macquarie has been a steady dividend payer. Dividends in FY May 2010, were AUD $ 1.72, and FY2011, were AUD $ 1.86, with anticipated dividends of AUD $2.10 and AUD $2.70 in FY2012 and FY 2013, respectively. This would represent an 18% annual dividend increase from 2010 to 2013. The firm has a goal of distributing at least 60% of income in dividends.
As the dividend is paid in Australian Dollars, a weaker US dollar creates a higher distribution when converted into USD. For example, Macquarie pays its dividend semi-annually, in November and May. The Nov 2010 dividend was AUD $0.86 and the just announced May dividend is AUD $1.00. Currency exchange rates in November were AUD $1.00 : USD $0.96 while currently the rate is AUD $1.00 : USD $1.09. The November dividend converted to USD equaled $0.82 and the May dividend will be close to USD $1.09, for a total annual distribution to US investors of USD $1.91.
With its current share price of USD $38.50, trailing 12 month dividend yield is 4.9%, substantially outpacing Macquarie's rivals.
To fully appreciate the impact of the US dollar decline, retrace back to April 2010, when the exchange rate was AUD $1.00 : USD $ 0.86. At this exchange rate, the same annual Australian dollar dividend of AUD $1.86 would have converted to USD $1.60, or about 19 percent lower than the actual payout US investors received.
With a large percentage of Macquarie’s income generated overseas, a strong Australian dollar creates additional headwinds. Management estimated the strength of the Aussie currency reduced earnings by about 5% last year.
As the financial crisis unfolded, return on equity declined. Historically, Macquarie has generated around 20% ROE, but in the first half of 2010, ROE shrank to 8.8%. While returns improved in the second half of the year to 10.5%, it still lagged historic performance. Driving earnings growth in the future depends on a return to the mid- to high-teens ROE.
Based on projected 2011 earnings, Macquarie trades about middle of the pack on a PE ratio basis. The following table compares forward PE ratios of its peers:
Deutche Bank (NYSE:DB)
7.2
BNP Paribas (OTCQX:BNPQY)
7.2
Credit Suisse (NYSE:CS)
8.1
UBS (NYSE:UBS)
8.9
JP Morgan (NYSE:JPM)
9.0
Macquarie (OTCPK:MQBKY)
9.2
Goldman Sachs (NYSE:GS)
9.3
Citigroup (NYSE:C)
10.4
Morgan Stanley (NYSE:MS)
12.3
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Macquarie is trading at about 1.0 times book value with a 2012 ROE estimated at 11.5%, and is also in the middle of its peers. On the low end, Citigroup is valued at 0.7 times bv with an ROE of 7.7, while on the high end Credit Suisse and UBS are valued at 1.2 times bv with an ROE of around 15.
Earnings at Macquarie are expected to climb from AUD $2.75 last fiscal year to AUD $3.50 this fiscal year, with AUD $4.02 anticipated in FY2013 and AUD $4.50 in FY2014. These estimates are based on marginally higher ROE over the same timeframe. If ROE were to gain traction again, earnings could outperform.
Using the current forward PE ratio, Macquarie could trade up to the mid to high $40s over the next two to three years. In addition, the potential for substantial dividend growth should generate dividend yield on invested capital exceeding 6.7% to 7.0%. Total stock returns could be in the 12% to 15% range.
Longer term investors may realize better returns as ROE, earnings, and dividends continue to grow over time. Keep in mind, management has at least $3 billion of excess capital and $6 billion of excess liquidity that could be used to fuel continued business expansion.
For US investors, investment performance will partially depend on the trend in the AUD to USD exchange rate. Currently at all time lows to the AUD, if the USD were to rally from here, returns would be a bit muted. However, if the USD maintains its depressed levels or continues its decline, investors will continue to reap the exchange rate benefits.
While not anticipating an additional 26% currency decline, such as the USD has experienced over the past 12 month against the AUD, the USD probably will not return to its April 2010 exchange rate levels. A more appropriate forecast could be for stability in the range of $1.00 to $1.05. These exchange rate levels would create acceptable investment returns based on the conservative nature of management.
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: I am long OTCPK:MQBKY.