Macquarie Group: Result 2013

Macquarie Group’s share price has spiked 11% following the announcement of its full year results (the company has a 31 March year end), and is now up 116% since reaching a low of $19.94 on 26 September 2011.

Since upgrading to a Strong Buy in Chaos amid the storm: The upgrades on 5 Aug 11 (Strong Buy – $22.97), it has risen 88%.

Eighteen months ago, during a presentation where I suggested two of the company’s divisions were worth more than the company’s total market value I was treated to more than a few sceptical looks. The price increase since then is sweet, as is the vindication.

Higher top line revenue growth would have been pleasant but the full year result shows that the company remains profitable, and laden with potential if and when the global economy recovers.

Operating income fell 4% to $6.7bn compared to a year earlier, but with expenses slashed by 10% to $5.5bn – chiefly due to staff cuts – net profit increased 17% to $851m while return on equity increased from 6.8% to 7.8%.

Capital buffer

These returns are far lower than those achieved in the halcyon days prior to the GFC and it won’t be easy increasing them significantly without decent revenue growth. The company’s enlarged capital base provides a buffer against another global economic meltdown but it’s also a drag on return on equity, especially in a low interest rate environment. That’s the price of stability.

Earnings per share increased 20% to $2.51 and the final dividend was increased from $0.75 unfranked to $1.25 (40% franked, ex-date 13 May), bringing the annual dividend to $2.00. That puts the stock on a price-to-earnings ratio (PER) of 17 and a dividend yield of 4.6%.

In a sign that the company’s growth prospects are relatively modest, the board is aiming to pay out 60-80% of profits as dividends; high for an investment bank, but in the absence of major growth opportunities, sensible.

The divisional profit split told a familiar story with the less sexy annuity-style businesses performing well; The funds management division increased profit 17% to $755m; the corporate and asset finance division produced a flat result of $694m; and the banking and financial services increased profits 22% to $335m.

The market-facing businesses, though, are struggling, which is why staffing is being cut. The fixed income and currencies division produced a 4% increase in profit to $563m but Macquarie Securities lost $50m (down from a $194m loss last year) and Macquarie Capital produced a miniscule profit of $150m, up from less than $100m last year.

Collectively, these businesses are a drag on profitability. But if and when corporate market activity improves, it will be these businesses that deliver far higher profits.

Stable, safer business

When we banged the drum that this stock was cheap in the three part series Macquarie: Inside a Strong Buy on 12 Oct 11 (Buy – $24.89), there was a large margin of safety in the 19% discount to net tangible assets (NTA), a PER of 8.9 and a 7.4% unfranked dividend yield.

With the share price almost doubling since then, today’s buyer is far more reliant on Macquarie’s ability to produce higher profits when business confidence returns. That’s when the floats and takeovers will come, but when that might be is anyone’s guess.

Macquarie is now a more stable, safer business with divisions that rise and fall with economic activity balanced by regular income from annuity-style businesses. The current price means you’re not paying a large premium for the market-facing businesses when or if they recover while the 4.6% dividend yield will look even better if interest rates fall further and the dividend increases next year.

As a result, we’re increasing the portfolio limit slightly to 7% in line with other recent changes. If you’ve profited from this recommendation, that should make your decision to rebalance your portfolio, and by how much, a little easier. As for the growth portfolio, the 5% holding remains.

The stock price has increased 16% since 5 Feb 13 (Hold – $37.16) and, with the investment case firmly on track, we’re sticking with HOLD.

Note #1: To celebrate the returns this recommendation has made for members, I’m taking my young son to see heavy metal band Tool tonight. Some people probably thought they were watching another tool at that presentation 18 months back. It seems fitting that tonight, this tool will be in the audience watching the real thing.

Note #2: The model Growth portfolio owns shares in Macquarie Group. A review of Westpac’s interim result will be published on Monday.