Counting dollars at Macquarie

If asked which Australian company had benefitted most from the decline in the Aussie dollar, you'd probably think of the likes of ResMed, Cochlear and Computershare. But even these companies, with 90% plus of their revenues coming from overseas, would be hard-pressed to better Macquarie Group.

Since 2011, Macquarie Asset Management (MAM) has increased assets under management (AUM) by 10% a year, to $487bn, and base fees by 12% a year. With costs growing at only 3% a year, the division's profit contribution has expanded by a remarkable 29% a year, to an estimated $1.8bn for the year finishing next month. That will double its share of group profits from 20% in 2011 to just shy of 40%.

At the heart of this improvement is Macquarie Investment Management (MIM), which has increased its AUM by almost 12% a year, from $205bn to $345bn. Base fees have risen slightly more, by around 13% a year and profit growth no doubt has been above 30%.

Slowing growth

Heady stuff. But a slide in last week's operational briefing gives some cause for alarm. Of MIM's total AUM growth from 2011 to 2015 (excluding a $9bn outflow from mergers and acquisitions), 56% has been down to the lower Aussie dollar, with 81% of the assets denominated in other currencies. A further 30% is the result of rising markets (the numbers are to 31 Dec 15), which leaves just 14%, a paltry $21m, coming from fund inflows – growth of just 1.9% a year, in line with the overall industry.

MIM boss Ben Bruck even claimed this as a slight success, given that most of the industry growth has been from 'passive' (index-tracking) strategies and that Macquarie's direct peers in active strategies had only grown by an average of 1.2%. Still, it makes you wonder what might happen to the AUM if markets fell and the dollar rose.

In fact, things are not as bad as they might seem. In response to a question at the briefing, MIM boss Ben Bruck made the point that, over the cycle, it's reasonable to expect some growth in asset values, and that given the operational leverage from a relatively fixed asset base, profits could be expected to grow faster. It's a fair point – equities of course have famously grown by 10% a year or so over the past 100 years.

The trouble for MIM is that only around a third of its AUM is in equities, with most of the remainder in bonds, which we wouldn't expect to grow over the cycle. Even so, it's reasonable to expect asset growth of a few per cent across the cycle and, with a per cent or two of inflows and some operational gearing, it's not hard to imagine growth across the cycle in the high single digits from this business.

We'd expect a little better from Macquarie Infrastrucutre and Real Assets (MIRA), since it is of course based around real assets that should grow across the cycle. Overall, then, we'd pencil in growth in the high single digits for MAM which, as we've already noted, is now contributing almost 40% of group profits.

Acquisitions drive asset finance

The next biggest profit contributor is Corporate and Asset Finance (CAF), which should chip in a bit over 20% of this year's group profits. The division now has about $40bn in loans and leases, after adding around $12bn in 2015 with the purchase of the AWAS aircraft leasing business and the Esanda dealer finance portfolio from ANZ.

The acquisition of AWAS assets, in particular, took place gradually over 12 months, so 2016 profit for CAF is only expected to be 'broadly in line' with 2015. However, the two deals are expected to add about $150m to group net profit in 2017, which suggests they might add around 15% to CAF profit. With organic growth of around 5%, the division's profit could rise by around 20%. Acquisitions are likely to keep this division bubbling along, but we'll again reckon on growth in the high single digits from this business to be conservative.

So, we've got around 60% of the group growing at a decent clip. What about the rest? Here's where it gets tricky. The only actual downgrade in last week's briefing was for Commodities and Financial Markets, which provides hedging and other risk management services to corporate clients. This division is now expected to be 'down on FY15', instead of 'broadly in line', with fourth quarter 'trading to be lower' than the three months to March 2015. In 2015 it contributed $835m, so if we pencil in $750m for 2016 (a smallish downgrade since it was trading in line until December), that would amount to about 16% of group profit.

Black box

The problem here is twofold: first, it's a bit of a black box; second, it's a volatile black box. In 2011 the division contributed $575m in net profit and this has since ranged between $539m (in 2012) and $835m (2015) before settling back at our guesstimate for this year of $750m. Probably the best bet here is to assume profits stay flat, although there will likely be some growth over the cycle if only due to inflation (remember that?).

After a bad year in 2012 where it contributed just $85m, Macquarie Capital – a traditional corporate finance business providing advice, underwriting and other services for clients involved in corporate transactions – has been showing steady growth to a $430m net profit in 2015. In 2016 its contribution is expected to be 'up', and we'll pencil in $480m, or about 10% of the group total. This business is highly dependent on market sentiment and with that on the slide, we'll assume no growth.

The final pieces of the jigsaw are Banking and Financial Services, which provides personal banking and wealth management services, and the stockbroker Macquarie Securities Group. Between them these businesses contribute about 10% of profits and we'll assume no growth, which is largely what's happened over the past five years (with some volatility for MSG in particular).

Millionaires

So how should we value all of that? The temptation with a collection of different divisions like this is to do a 'sum-of-the-parts' valuation. The difficulty here, though, is that central costs eat up around 40% of the overall divisional profits. The standard way to treat this would be to capitalise the costs with a fairly arbitrary multiple of around ten times. Thanks to all the millionaires at the millionaires' factory, though, in this case this would become the largest component of value – albeit negative of course. (As an aside, this perhaps highlights the potential value in breaking up Macquarie, and there's a report today on afr.com that someone is sizing it up.)

So we'll stick to aggregating our divisional growth rates and applying a multiple to that. With 60% of the business growing in the high single digits, then, and the rest barely growing at all, we'll assume a long-term growth rate of about 5%. Against that, the stock is now looking pretty attractive, with a forward multiple of about ten times the diluted earnings per share of around $5.90 now expected for the year to March 2016.

Obviously a business like this has the potential for nasty surprises from time to time (although less so now for Macquarie, with the increased contribution from its annuity-style businesses), and sentiment can swing around wildly – as we're seeing at the moment. So we'd recommend buying into this stock gradually – perhaps buying up to half the maximum weighting to begin with, to allow room for top-ups if the price continues to fall. With that caveat, though, and noting a drop in our Buy price to $60, we think that below $60 Macquarie Group is a BUY.