Millionaire's factory sets wheels in motion

The composition of Macquarie’s earnings has changed dramatically since the financial crisis and the group is rapidly winning back its reputation for making millionaires.

Macquarie Group’s shares have been trading at their highest levels since September 2009 and today’s revised earnings outlook explains why.

Ahead of an investor presentation the group will make later this week Macquarie, which had foreshadowed an improved result at its operational briefing last month, said it expected its results for the 2013-14 year to be about 40 per cent to 45 per cent higher than for the 2012-13 year.

Given that Macquarie earned $851 million last financial year, that implies it expects to announce a profit of between $1.19 billion and $1.23bn for the year to March.

That would be comfortably its best result since the outbreak of the financial crisis and the difficult years that followed. As recently as 2012 Macquarie’s profit dropped to $730m, mainly because its market-facing businesses -- Macquarie Securities, Macquarie Capital -- and its fixed income, currency and commodities (FICC) division were struggling.

Macquarie’s CEO Nicholas Moore resisted the urging of some in the market to exit those businesses to focus on Macquarie’s ‘’annuity’’ businesses -- its funds management, corporate and asset finance and banking and financial services units -- although he did carve deeply into the cost bases of Macquarie Securities and Macquarie Capital.

The FICC business held up quite well, generating average earnings of about $600m through the post-crisis years. In February Macquarie said that while the business had the potential to produce a result broadly in line with last year’s $563m, it was likely to be lower than that.

Today Macquarie said it now expects the FICC contribution to be in-line with last year’s or slightly higher after it experienced improved market conditions.

Both Macquarie Capital and Macquarie Securities, according to last month’s briefing, are expected to produce improved results. Macquarie Capital generated $150m of earnings last year but Macquarie Securities lost $50m. In the September half of this financial year the securities business made $71m and Macquarie Capital $101m.

Those are the divisions that have experienced the deepest cost-cutting -- Macquarie Securities’ cost base was slashed by more than 25 per cent in 2012-13 and Macquarie Capital’s by nearly 20 per cent.

They are also the divisions which are most leveraged to any upturn in market activity, even if there is no expectation that Macquarie Capital, which pre-crisis was (thanks to the now-discarded listed satellite funds model) producing nearly two-thirds of the group’s earnings, will return to its former glory.

Those businesses represent Moore’s exposure to market upside, with the composition of the group‘s earnings having changed dramatically since the crisis.

Moore has significantly expanded the annuity businesses, which Macquarie said today were all performing well. Their combined December quarter contribution was higher than in the September quarter and in the same quarter a year earlier.

The disparity between the returns on equity the divisions are generating -- the annuity business produced a return of 19 per cent in the first half of this financial year but the markets-facing divisions returned only six per cent – illustrates both the quality of the annuity businesses and the strength (or cost) of Moore’s conviction that the markets-facing business can eventually generate respectable returns in a stronger markets environment.

Moore’s faith in the prospects of the FICC business was underscored when Macquarie recently lost out to Swiss-based trader Mercuria in a bidding duel for JP Morgan Chase’s commodities trading business. Mercuria paid $US3.5bn.

Macquarie shares shot up almost three per cent, or nearly $1.60, today. With the shares above $56 each, the group’s share price is about 60 per cent higher than it was a year ago.

The group may, in real terms, struggle to ever match the $1.8bn of profit it made in the bubble-like environment in 2008, just ahead of the financial crisis, but it is closer to regaining its reputation for creating millionaires than it has been since then.

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