We recently researched Macquarie Group (ASX:MQG) in The Dynamic Investor on 8 March 2022 after a sustained period of weakness in the shares led us to re-evaluate the fundamentals. Since our research report, the shares have jumped by ~13%. But have the shares merely recovered or is there scope for a more significant re-rating?
About Macquarie Group
Macquarie Group is a global provider of banking, financial, advisory, investment and funds management services. Its main focus is in making returns by providing a diversified range of services to clients. The Company acts on behalf of institutional, corporate, retail clients, and counterparties around the world. The earnings base is diversified across numerous financial markets and geographies. Two-thirds of its revenue is generated in offshore markets. The business mix is also highly diversified, with lending, client brokerage, and principal investments in both equities and credit. However, 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)).
Key Fundamental Drivers
Significant Future Growth Opportunities
1. Leveraging Off Increased Global Infrastructure Investment – MQG estimate that US$75trn would need to be invested in global infrastructure by 2040, 54% of which will need to go to Asia – a region in which it is already well established. The MAM (which is the leading manager of global infrastructure), CGM and MacCap divisions are all expected to benefit from this build-out, which will span several asset types.
The MacCap division was the number one global infrastructure financial advisor in 2021. It is driven by a tenured senior team, that continues to innovate and push into new markets – partnering with governments and the public sector, and benefiting from the broadening scope of private capital. Meanwhile, the opportunity for the CGM division is underpinned by the fact that it plays a major role in the physical movement of commodities between production and consumption, via infrastructure.
2. Investment in Renewables – MQG is a diversified developer and producer, with capabilities in all regions and in all renewable technologies. It has a long record and global expertise in infrastructure and energy markets. Renewables and green energy accounted for 9% of FY21 group revenues.
The MQG division with the largest green revenues exposure is MacCap, with an estimated ~25% revenue exposure in FY21. This is driven by renewables representing 40-50% of gains on sale in MacCap, and a lower percentage of advisory fees at 10-15%. Accordingly, with the Green Investment Group well regarded on a global basis (i.e. active in over 25 markets), there is potential for green revenue streams in MacCap to grow rapidly and represent a higher portion of group revenue (~15%) by FY25.
3. Commodities – The Company has benefitted from increased gas price volatility across EMEA, which it suggested had been driven by a mix of supply/demand side factors. CGM has a strong and growing presence in EMEA region, providing a full-service offering to their diverse client base. This is where they are actively supplying and trading across all liquid wholesale European gas hubs and continuing to expand into adjacent markets and jurisdictions across Europe.
MQG now expects commodities income to be significantly higher (~15%) on FY21. The recent energy price volatility in the UK/EU has continued into the current half (2H22), with the strong revenue performance for the six months to 30 September 2021 (1H22) likely to have been followed by an even stronger start to 2H22E. While some of these are cyclical tailwinds, the CGM division benefits from a structural increase in volatility and trading activity. In particular, the transition to renewables could create more uncertainty around energy supply.
Further, climate change is leading to more extreme weather episodes and spikes in energy demand. As such, the opportunity for MQG is that the CGM division can provide a global trading and hedging platform to help energy clients. There is also the potential for a growing market in CGM clients trading carbon offsets, or in the US trading Renewable Identification Number credits under the US Renewable Fuel Standard (RFS) program.
Are Lower Performance Fees a Concern?
MQG has a low portion of its revenue stream that is considered lumpy. These include performance fees, gains on sale of assets, and credit & impairment charges. Performance fees are typically the largest swing factors. Performance fees in 1H22 were down 57% in comparison to 1H21. This was a result of lower fees from Macquarie Infrastructure Partners (MIP III), Macquarie European Infrastructure Fund (MEIF 4), and other Private Markets-managed funds, managed accounts and co-investors.
Whilst performance fees have recently disappointed, it is worth noting that the low portion of lumpy revenue reduces earnings risk. Further, continued growth in equity investments, the increase in asset values over the past five years, and conservative accounting treatment (with ~75% of equity investments held at cost or lower) limit the downside risk from impairments/marking to market.
Overall, performance fees are expected to recover in FY22-24, especially as there is a strong pipeline of funds for Macquarie Infrastructure and Real Assets (MIRA).
Improved Surplus Capital and Low Gearing
Macquarie Group deployed significant capital in 2H21 and 1H22 (~$5.5b) given a period of sustained and material growth in capital requirements. Perhaps in order to take advantage of the strong share price at the tie, MQG raised $1.5b via a non-underwritten institutional placement. This was followed by a non-underwritten share purchase plan (SPP) to provide additional flexibility to invest in new opportunities, where the risk adjusted returns are attractive.
As a result, MQG’s group surplus capital position increased from $8.4b as at 30 September 2021 to $11.5b as at 31 December 2021. Accordingly, it is expected that MQG will look to make further investments in this business, with gearing levels also quite low (~7.5%).
MQG’s investment appeal is underpinned by: i) Low volatility in earnings, ii) A high focus on risk management, iii) Diversity in MQG’s geographic business mix, iv) Strong levels of Return on Equity (ROE), v) Quality management and vi) Balance sheet strength.
With strong momentum continuing across all business, and the significant growth opportunities being longer-term in nature, we consider that the shares are likely to regain their premium rating.
A few weeks ago, MQG shares were sitting at a major support level. They managed to bounce off that and it now appears as though MQG is getting back into an uptrend. Short-term momentum indicators suggest it is slightly overbought, so any dip over the next several days back towards $190 is a buying opportunity.
Michael Gable is managing director of Fairmont Equities.
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