MACQUARIE GROUP FH27 RESULT--Tier two holding--New CEO, same game plan?

 MACQUARIE GROUP FH27 –Tier two holding -- New CEO, same game plan?

The first time I met MQG management was in 1992, ok that is starting to sound like a long time, even to me, and I have followed the group ever since. IMO, the success of MQG rides on three factors. Firstly, the creative talent of the people; I see MQG as an evolving combination of businesses, changing as opportunities arise. Secondly, the capital allocation skills and financial strength of the group; MQG backs its winners with more capital and ruthlessly shutters its failures. Financial strength has been beyond reproach for almost the whole period I have watched them and continues to be so. Thirdly, the risk controls that are non-negotiable, that includes the incredibly tricky balancing act of dividing the spoils between staff and shareholders so both win. There is clear moral hazard in investment banks that requires careful management. The new CEO, Greg Ward, I have known from his time as CFO many years ago. He is now an MQG veteran, having run BFS for the last several years, and I expect that the group framework will remain in place. People who compare MQG to the retail-focused Big Four are missing the point, IMO.

The following review will be brief due to it being an interim result.

Forecasting MQG's next-year profits is not really doable or worth my time, IMO. The reason for that is that two large swing factors can be based on timing, being performance fees (PF) and especially gains on asset sales. FH27 saw asset sales being much higher and PF’s being lower. The profit on sale of Macquarie Air Finance in MAM was the large contributor to this result. From a valuation perspective, I use equity deployed and a long-run ROE, which smooths out the lumpiness of the gains and losses. ROE: this result was 13.8% (pcp 9.6%).

Divisional results: NPATs were MAM $1.5b, up 28%, CGM $2.0b, up 83%, BFS $0.8B, up 6% and MCap $0.3b, down 61%. Interesting aspects of these results were MAM with higher profits on asset sales and lower PF’s, restructured its AUM, and positive IMO. Huge results from CGM as gas and power, resources, asset finance, as well as FX/interest rates and credit trading all fired up. CGM is a specialised and unique business, and when volatility increases in its areas of focus, profits go much higher. BFS, the bank competitor, saw higher volumes and lower margins. The digital bank is expected to continue to take share from the Big 4. Finally, Mcap had a poor half, with realisations down and market activity in Australia subdued. The private credit portfolio continues to generate an attractive spread, and MQG limited growth into this segment some time ago. Impairments were higher but still low. The equity book went from a profit of $165m to a loss of $112m, attributed to the timing of realisations, which are inherently opportunistic. The equity book is $5.6-6B, focused on small developing businesses.

The group sold out of the public equity business in NA and Europe, which is a good move, IMO, too competitive. MQG is a specialised niche (big niche) asset manager. Also, ROE is recovering from the lag due to carrying development assets on balance sheets. The size of these green assets is large and impacted ROE while they reached profitability. MQG appears to be less willing to carry these on balance sheet now and is using third-party money and coinvesting. That moves them down the risk-reward spectrum. The capital buffer remains large, reducing ROE while also reducing risk.

Expenses were well held by the group. However, tech and compliance spend remain two areas of drag in this area. Will look at this more closely at the full year. It is a CODB and also a barrier. Maybe this spend just makes the business less attractive.

MQG reported a breach around structured interest rate risk hedges. The group self-imposed a $100m allocation capital overlay. Being able to identify breaches early and act is critical to the group.

SUMMARY and VALUATION

MQG is a solid if unspectacular compounder. I am not that keen to add business with huge leverage, as most financials have; MQG grows in a steady risk-adjusted manner, is well managed and conservatively financed, and adds a different income stream to the rest of the portfolio.  

At $244 and assuming a 5Y eps cagr of 8% and an exit multiple of 16X gives a return of 7%. A 10% return is generated at a share price around $220. The challenge here is to adjust for unusually high or low profit bases set by PF’s and profit on asset sales.

Of course, MQG needs to earn its position in the portfolio, and the anchor here is the regulatory/compliance capital requirements that limit growth, as well as the profit share, which is a cost that must be assessed in this investment when compared to other alternatives.

 

 

 

 

 

 

 

 

 

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