We recently researched the Macquarie Group (ASX:MQG) in The Dynamic Investor after the Company reported its financial results for the 12 months to 31 March 2023 (FY23).
MQG shares typically recover after the release of financial results. While this eventuated in the most recent case, the shares have since weakened as the market concerns about the earnings outlook have resurfaced. In this note, we present our case as to why MQG shares are likely to recover.
Overview of Macquarie Group
Macquarie Group is a global provider of banking, financial, advisory, investment and funds management services. Its main business focus is making returns by providing a diversified range of services to clients. The Company acts on behalf of institutional, corporate and retail clients and counter-parties around the world. The earnings base is diversified across numerous financial markets and geographies, with two-thirds of its revenue generated in offshore markets. The business mix is also highly diversified, with lending, client brokerage, and principal investments in both equities and credit, but its largest business is in capital-light asset management.
The Company operates four divisions that are categorised as either annuity-style businesses (Macquarie Asset Management (MAM)), and Banking & Financial Services (BFS)) or capital market-facing businesses (Commodities & Global Markets (CGM) and Macquarie Capital (MacCap)).
Group Outlook Hinges Largely on CGM Division
The CGM division shapes as a large earnings swing factor in FY24. In context, the CGM division now accounts for ~57% of group earnings. MQG have indicated that revenue for the CGM division in FY24 is expected to by ~$3.7b, which is down from ~$6b in FY23 but above the FY22 level of $3.3b.
The key reason for the decline in earnings is that elevated volatility levels experienced in global gas markets since 2H22 have largely abated in 4Q23. The high base from 2H23 is unlikely to be lapped and management now expects commodities income to be up by ~10% compared to FY22, albeit volatility may create opportunities. Accordingly, consensus downgrades have followed, as guidance for the BFS, MAM and MacCap divisions is mostly subdued.
Key Fundamental Drivers
We consider that there are several factors that underpin the potential for FY24 earnings to surprise on the upside. We discuss these in further detail below.
Revenue for CGM Division May Surprise on the Upside
Recent operating conditions have been highly for favourable for CGM, and cycling FY23 numbers will likely prove difficult. However, it is worth noting that CGM’s underlying client business (a measure of more normalised performance) also grew by an estimated ~30% in FY23.
Given MQG has already said volatility in some of its CGM operations started to subside in 4Q23, it is reasonable to expect that FY24 earnings risks are likely weighted to the downside. However, it is worth noting that similar risks in prior years did not eventuate. Further, management has a history of guiding conservatively on commodities, as the volatility that can arise from geopolitical, weather and other events that can swing earnings materially.
Divisional revenue is likely to be supported by volatility in energy markets, which are mostly structural factors. These include: i) US pipeline and storage constraints, ii) Growing international LNG trade, iii) Variability in global weather patterns (which creates demand for MQG as they specialise in the ability to mover gas and power to where it is needed) and iv) The energy transition towards wind, solar and nuclear, (where the energy transition is relevant across all of CGM’s activities, markets, and client sectors).
Additional Gains on Sale
MQG generated a decline in gains on sales for FY23, from $3.2b in FY22 to $2.1b in FY23. A recovery back to FY22 levels is unlikely, given that industry Merger & Acquisition volumes remain subdued. However, there is likely to be a recovery in the latter part of calendar year 2023. In addition, MQG has investments in the Green Energy and Infrastructure segments, where public asset prices have performed better than average and there are signs of activity. For example, MQG’s Macquarie European Infrastructure Fund 5 (MEIF5) is selling eight offshore wind farms at the start of FY24. In context, additional gains on sale of ~$500m adds ~5% to NPAT in FY24.
Further Funds Can Be Deployed
As at 31 March 2023, MQG had A34.8b of equity to deploy on an Equity Under Management (EUM) basis, up 75% on FY22. Given that MQG typically gears up its private market funds (within the MAM division), on an Assets Under Management basis, it is estimated that the available deployment is closer to ~$50b.
Notably, there is strong realisation potential in private markets funds, with an estimated ~$30b of EUM across >20 funds expected over the next few years. MQG continues to deploy into real assets with infrastructure and real estate both focus areas, as well as in green energy, while reducing its appetite for private credit.
Cost Management Remains Strong
The Company reported higher headcount and staff costs in FY23. Employment expenses (which account for ~63% of overall expenses) increased by 15%. This was ahead of revenue growth of +10%. Despite this, a large focus on productivity gains means that material upward revisions to operating expense forecasts over FY24-26 are unlikely.
Fundamental View
MQG shares are currently trading on a 1-year forward P/E multiple of ~14.5x, which is down from recent highs of ~20x. We consider that the current weakness likely presents an attractive entry opportunity. As highlighted above, there are several factors that underpin the potential for FY24 earnings to surprise on the upside, which we expect may restore MQG’s historical premium rating.
Chart View
A few months ago we saw MQG make a higher high and a higher low, finally breaking the downtrend that had been in place during 2022. However, we can also see a long-term horizontal range which is also now starting to tighten up. This will give us a couple of different trigger points. With MQG at the bottom of this range, we have a level which represents a buying opportunity. The next major resistance levels are at $180 and then up near $190. Pushing through each will represent new buying opportunities with a move above making $190 making the long-term chart look very bullish again. However, a fall under $170 would then have us targetting support down near $160.
Michael Gable is managing director of Fairmont Equities.
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