Investors are starting to load bull market expectations into Macquarie Group's share price if the reaction to chief executive Nicholas Moore's modest recasting of the group's profit outlook is a guide.
With the usual caveat that it all depended on how the markets travelled, Moore told Macquarie's annual meeting that Macquarie boosted earnings in its first three months to the end of June and remained on track to beat its 2012-13 profit of $851 million in the full year. The market consensus is that earnings will be about 27 per cent higher.
Moore said that the components of the result would be slightly different than previously expected. The group's funds management business is growing faster than expected, picking up more performance fee income than anticipated and getting a boost from the decline in the value of the Australian dollar, so its expected profit contribution has been upgraded. Macquarie's resources project financing arm, on the other hand, will probably contribute less than expected, as the resources sector downturn creates some impairment charges.
Overall it's a wash, but Macquarie's shares fell by $1.07 or 2.3 per cent on Thursday because investors wanted a profit upgrade, sourced basically from the parts of Macquarie's business that were pounded hardest during the financial crisis: Macquarie Equities, and Macquarie Capital, the division that houses the group's corporate advisory business.
Macquarie is not within a country kilometre of the profits it was booking before the global crisis, and key profit catalysts including Macquarie's famous listed infrastructure funds management manufacturing machine have wound down.
There is however room for what Maquarie calls its "market facing" operations to significantly boost their profit contribution if the market recovery continues, and what is still a 25 per cent price gain for Macquarie since mid-April is partially built on the assumption that it is under way.
In its first-quarter update on Thursday, Macquarie confirmed predictions of higher earnings this year for both Macquarie Securities and Macquarie Capital. Both are building off depressed bases, however. In 2007-08, Macquarie lifted net profit by 23 per cent to $1.8 billion. Earnings before corporate expenses were $4.6 billion, and Macquarie Capital contributed $2.9 billion, 63 per cent of it. Equity market earnings were $732 million, 16 per cent of the total.
Within last year's $851 million profit, Macquarie Equities actually lost $50 million on top of a $194 million loss in the previous year. Macquarie Capital contributed $150 million, 17 per cent of the total.
The reduction in market-facing profits is the key to a slump in Macquarie's return on equity since the global crisis erupted.
Its $1.8 billion profit in 2007-08 represented a return on equity of 23.9 per cent, well above an average return of 11 per cent for a peer group of banks, and its 10-year average return was 25.1 per cent, again easily outstripping a peer group average return of 16.3 per cent. The $851 million profit in 2012-13 represented a return on equity of only 7.8 per cent. The three-year average return is 7.8 per cent, and Macquarie's 10-year return on equity now averages 17.3 per cent.
Macquarie remains ahead of its competitors on this important measure. An international peer group that includes Bank of America, Barclays, Credit Suisse, Deutsche Bank, JPMorgan Chase, Morgan Stanley and UBS returned 4 per cent on invested equity in 2012-13, and a 10 per cent return in the past decade.
The crisis has narrowed Macquarie's lead, however, and it is not clear that it will widen again if a bull market develops.
Moore said on Thursday that Macquarie Equities was back in profit in the June quarter, but a market recovery will tend to lift all broking and investment banking boats in that area.
And while measures of takeover activity vary, Macquarie Capital appears to be the third-ranked adviser by deal value in this market since 2011, behind the leader, Goldman Sachs, and UBS. It is also third ranked this year, behind Goldman and Lazard.
That's about as far down the league table as it will want to go. Takeover activity is still in the doldrums: KPMG reported on Thursday that deal numbers declined globally in the year to June and that the total value of deals was back to 2012 levels.
When takeovers take off, however, they are huge profit generators, not just on advice but in debt and equity takeover funding. Corporate advice was one of Macquarie's big edges before the crash. It has to be in the next boom, too, if the group is to outperform.