Stock: Macquarie Group
Market Cap: $9.7 bn
The ‘millionaire’s factory’, the ‘fat cat’s lair’ – Macquarie Group has been given many terms of ‘endearment’ over the years but shareholders weren’t complaining as the share price almost hit $100 in May 2007. Since then, it’s been another story altogether and the financial sector as a whole has been walloped. Young hopefuls across the land used to aspire to make their big break into investment banking attracted to the seemingly outrageous salaries and glamorous lifestyles. But now such images have been turned on their heads and replaced with a more sobering reality of companies plagued by debt and severe write-downs. With Macquarie’s success having been primarily tied to sharemarket performance and business activity levels, the company and all of its international peers have been forced to reconsider the ways they do business and several have even disappeared into oblivion.
Is Macquarie still a powerhouse?
Despite the flack taken over the paypackets of the head honchos, Macquarie remains one of the world’s few investment banks to have been profitable throughout the global financial crisis. The likes of Lehman Brothers and Merrill Lynch, who were once global stalwarts of the industry and many times larger in terms of capitalisation, were quick to fall victim to the crisis and crumpled in a heap. In addition, whilst surviving peers have bled multi billion dollar losses over recent quarters, Macquarie reconfirmed its profitability just last week in its FY09 report.
So Macquarie hit the headlines again, releasing its FY09 results to the end of March. Investors might have been alarmed to see that earnings halved from last year’s record profit, however NPAT of $871m was in line with the guidance provided in February, contributing to a recent jump in the share price. The market seemed to be saying that although the fall in profit was severe, it must be considered within the current global context of the investment banking industry and the challenges being faced. And on this note, Macquarie is not only keeping its head above water but remains a very viable business.
But what caused the halving of profits? The fall was due to a combination of lower income and asset write downs. The collapse and extreme volatility of equity markets during the period saw trading income decrease by 37% on the previous year to $1.15bn, primarily due to a near wipe out in earnings from Macquarie’s equities division. Fee and commission income from its investment banking and funds management operations also suffered, down 15% to $4bn. Corporate activity experienced a slowdown as companies saw their values drop and management teams had their hands full in simply keeping their ships afloat during the financial crisis, rather than capitalising on any corporate deals. A rare ray of sunshine for the period was Macquarie’s traditional banking operations. The division posted a solid result, buoyed by a 38% surge in deposits, with net interest income (NIM) rising 15% to $938m. Apart from this, the bull market that saw Macquarie surge to fame is now officially over and the profits that once cascaded through the Martin Place doors are looking a little harder to come by.
In a similar vein to recent NAB and ANZ results, write downs to the tune of $2.5bn also plagued the Macquarie full year result – 60% of which was attributable to its listed satellites and assets held within its funds management division. Loan loss provisioning was the other significant source of woe, accounting for 20% of the write downs. Further provisioning for write-offs might be expected as the global economy continues to struggle but the company has forecast that FY10 will feature fewer provisions and impairments than the year just passed.
So whilst there were many factors weighing down Macquarie’s latest earnings result, it actually could have been much worse. Put simply, the tax man was very generous with last year’s restructure resulting in the company paying little to no tax for the period. Macquarie’s official tax rate during FY09 was 1.5%, but this is obviously a one-off occurrence and tax levels will return to normal in FY10. Had the company been subject to its usual 15-20% effective tax rate, its net profit could have been as low as $700m.
What does all this mean? Can Macquarie recover, or has the bear left it battered and still bleeding?
Macquarie’s success is linked to a recovery in the economy, the timing of which is still uncertain. With the majority of its competition having been decimated by the financial crisis, we believe Macquarie will survive and eventually prosper. However flaws associated with its listed satellite model are unlikely to be tolerated in this more conservative ‘brave new world’. The company needs to formulate a fresh growth strategy that generates returns for all stakeholders rather than just the parent company and its employees.
So while we await evidence of a new growth strategy to emerge, our preference leans towards other exposures within the financial sector. However now that Macquarie has become one of the sole flag bearers for the Australian Investment Banking sector, we suspect a valuable entry point will emerge at some point.
Joshua Terlich is an analyst at wise-owl.com. Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.
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