In the fallout from the Brexit vote several brokers believe it only natural that investment bank Macquarie Group (MQG) will re-base 2017 expectations, probably at its July AGM. Bell Potter believes, just purely based on FX movements since March, profit is likely to be 3% lower across the forecast horizon.
Around 24% of the group’s income is generated in EMEA – Europe, Middle East and Africa. Assuming the latter two are immaterial, Bell Potter estimates two thirds is from the UK and the remainder from Europe. Morgan Stanley calculates EMEA accounts for around 18% of Macquarie’s total assets under management. Both brokers highlight the fact the majority of the company’s investments in Europe/UK are in essential specialised infrastructure funds.
Hence, this does not justify a 12% pull back in the share price in the past week, Bell Potter maintains, given the largely defensive nature of the underlying assets in that region, and the de-risked annuity-style businesses. The broker, not one of the eight monitored daily on the FNArena database, remains content with a strong Buy rating.
In sum, Bell Potter lowers profit estimates by 6%, with half this downgrade attributable to FX translation and the rest to lower yields and market volatility. The price target is lowered by a similar magnitude, to $83 from $88. The stock remains one of the broker’s high conviction calls given the long-term growth potential and sector leading positions in terms of capital, funding and liquidity.
To highlight the difference with the circumstances in the wake of the global financial crisis, Bell Potter notes the GFC affected the company most in 2009. In that scenario its total income declined by 33%, largely from asset and equity investment write downs, and real estate banking and proprietary trading losses.
The fact that annuity-style components now contribute around 60% of total income and around 70% of net profit underscores the current de-risked operating model, in the broker’s view.
Morgan Stanley suspects the British vote could affect the firm via the impact on asset values and operating conditions in its market-linked business and also envisages downside risks to FY17 estimates. Management has stated it expects a “solid principal realisation pipeline in FY17” but this is considerably more challenging in the short term, the broker suggests. On the other hand, market volatility may improve the prospect of performance fees from the infrastructure funds.
The broker calculates that every 10% fall in the Australian dollar reduces Macquarie’s earnings by 7%, noting the AUD/USD fell 2% while AUD/GBP and AUD/EUR rose 6% and 1% respectively in the wake of the vote. This implies a net impact on earnings of less than 0.5%.
That said, Morgan Stanley’s cross asset analysts believe Britain’s decision to leave the EU is a negative for risk premiums and, even though Macquarie Group has a diverse mix of businesses, the market is reminded that around 60% of revenue is linked to markets or asset prices.
Brexit will probably make the task of replicating FY16 even more challenging, Citi agrees. Yet this broker is much more bearish about Macquarie Group’s outlook, suggesting market turmoil usually corresponds with a fall in earnings.
The broker suspects, while infrastructure funds may be a beneficiary of the lower-for-longer interest rate settings, near-term performance fees are likely to fall in FY17 as a result of the absence of large, unlisted maturing funds.
Citi also notes revenue was boosted significantly in FY16 by the accumulation of gains on asset sales, yet the uncertainty brought about by a UK withdrawal from the EU will probably mean a continued reduction in global merger & acquisition activity.
The broker also believes the share price could unravel beyond the trimming of earnings estimates, as the stock’s rating unwinds. Valuation will likely be driven by market liquidity conditions and the performance of the Australian dollar and Citi suspects the stock may drift back to its $59 target.
The database has four Buy ratings for Macquarie Group, two Hold and one Sell (Citi). The consensus target is $72.28, suggesting 4.9% upside to the last share price. Targets range from $59 (Citi) to $85 (Credit Suisse). The dividend yield on FY17 and FY18 forecasts is 5.7% and 5.9% respectively.