Following on from our recent company update on Sonic Healthcare, another high-quality stock on our watchlist for the next market correction is Macquarie Group. Trading on just 15 times 2020 consensus earnings now, the stock is already interesting when the ASX 200 trades on 15.5 times.
The appeal is Macquarie’s structural growth in asset management, the buildout of its global commodities platform, resilience to investment market volatility and a lengthy record of under-promising and over-delivering. The stock would still sell off in a general sharemarket correction but we think a platform that can deliver consistent earnings growth has been built. Macquarie compounded earnings per share by 15 per cent per annum over the last three financial years and by 23 per cent per annum over the last five years. Dividends per share have compounded at 10 per cent per year over the 25 years since the stock listed on the ASX in 1996. Given this record and the outlook, we don’t see the case for pricing Macquarie in line with the broader market, which comprises numerous companies with volatile earnings and less growth. The market is undervaluing Macquarie for what it can deliver.
The old case for pricing Macquarie like a commercial or investment bank, which respectively trade on earnings multiples of 11-13 times (ASX major banks) and less than 10 times (US, for example Goldman Sachs) continues to fade as the group grows earnings when commercial bank earnings are flat, and as it diversifies away from traditional cyclical investment bank revenue streams like corporate advice.
Macquarie is also a superior investment to traditional asset management plays like listed funds management stocks. The group does not have the same concentrated exposure to fund outflows, poor investment performance, disappointing performance fees, market share losses to passive managers and declining fees for active management, and is well-placed to grow globally in both alternative and traditional asset management. The MIRA business, which invests in new and alternative asset classes, raised $8.7 billion in the December quarter, also won a $2.5 billion mandate and likely garnered at least another $7 billion in the March quarter. These are high-quality annuity revenues generated by 10-year closed funds investing in segments with structural growth, like infrastructure and renewable energy, as institutional investors increase their allocations to real assets. Fund inflows to the traditional Macquarie Investment Management (MIM) business should improve over the next two years, especially in Asia. Total assets under management were $532 billion on 31 December but will have risen with the rally on equity markets since then. This is exponential growth from $5 billion of assets when Macquarie listed. Overall, earnings multiples for MIRA and MIM have more upside than downside.
We think the stock remains in an earnings growth cycle where the return on equity is likely to improve as risks are diversified and managed lower, hence our valuation upgrade. Downside earnings risk is modest given support from rising base management fees, a pipeline of gains on sale and performance fees as $25 billion of assets under management across 16 funds mature in coming years, favourable operating conditions across most of the rest of the group, lower US tax rates and flexibility to lower the remuneration ratio. In our view the market will place increasing value on differentiated large companies which can grow globally when economic growth in Australia is subdued; two-thirds of Macquarie’s revenue comes from outside Australia. Group capital comfortably exceeds regulatory requirements and the strong balance sheet also makes accretive acquisitions manageable. The diversification of revenue across businesses that face financial markets and others driven by the real economy is a unique attraction.
Another reason the stock should trade at a premium to the market multiple is its record of conservative guidance since 2013. Initial guidance for each financial year has been for “broadly in line” or “up slightly” results but annual growth has ranged between seven per cent and 49 per cent and guidance for fiscal 2019 is +15 per cent. Macquarie has not missed its guidance since 2012 – a rare record on the ASX.
Downside risks include weaker operating conditions, overpayment for acquisitions, margin pressure from growing competition for assets and pressure on infrastructure valuations as bond yields recover from recent lows.
Clime Group owns shares in MQG