MACQUARIE GROUP FH25—Top 10 position—waiting for the ROE lift.

The following will not give an extensive group history, readers can look at past posts. Having said that I will give a brief recent background.

General

I think about MQG as a conglomerate of many businesses with the corporate function overseeing the critical roles of risk control and capital allocation. The past and future success of the group is dependent on the risk controls, the ability of the business units to identify, innovate, invest, grow, manage and often realise assets in a highly profitable manner, and the ability of the group to actively fund the growth businesses and cull the disappointments. The belief in management to continue this structure and its ongoing success is key to investing in MQG.

Comments on results

The overall result was Net Income up 4%, PBT up 15% and NPAT up 14%. These were adequate but not overly exciting results. ROE came in at 9.9%, around the cost of capital.

While the core business continues to grow units in what I think are mid-single percentages, several large swing factors always complicate MQG results. Estimating the next NPAT is always a lottery due to the swing factors (so I don’t waste time trying to do it).

The large swing factors are performance fees, the profit on asset realisations and volatility in the market-facing businesses. Of these, we saw an improvement in PFs to around 17% of PBT, that is at its 10Y average of 16%. Asset realisations are not specifically disclosed but the divisional results for MAM give a guide. The 6Y average is 15% of PBT and the current half delivered 4%. The realisation of assets is a big deal for MQG. The final large swing comes from the commodity trading division which partly relies on volatility in commodities.  Volatility increases both volumes traded and spreads, a double positive. Energy markets in particular have been benign despite plenty of geopolitical issues. That cost around $300m pretax about 13% of PBT compared to volatility over the last year.

Another issue that stood out was the great cost control exhibited in the result. Employee expenses on net operating income fell from 47.2% to 45.7%. Mainly this was in the Banking and Finance division, the digital bank, where large spending projects dropped out, and headcount was also lower. The BFS division did experience severe margin pressure as the banks fought back in the mortgage market.

The bank's private credit exposure has been a potential area of concern. In the Mac Cap division, the exposure was disclosed as $22.5B, up a little. Provisioning deteriorated from a writeback of +$117m to a charge of ($75m) pcp. Management stated that the reason was the completion of reversals (write-backs) in the previous periods and there had not been any fundamental deterioration in the book. Other disclosures were that the book has a 3-year duration, the LT historic loss rate has been 30bp and the total provisioning is about 300bp. For the book to get into trouble loan losses would have to be 3X the historic average on these numbers. Of course, that is possible but looks under control at this stage. Sectoral exposure remains in software and tech-enabled 35%, healthcare 14% and Financial and Insurance services 14%. There are likely to be issues in private credit markets at some point, MQG's results will depend on the robustness of the book, with MQG relying on their depth of knowledge and network.

What is the ROE outlook?

MQG disclosed, as they always do, a comparison of ROEs of the Annuity style and Market-facing businesses with their 18Y averages. For the Annuity style businesses, the current ROE was 14%, versus a 22% average and 12% currently for the Market-facing business versus a 17% historic average. The Market facing business’ issues with volatility were discussed above.

The group carries a $9.8B surplus capital. With equity at $32.8B even reducing the whole surplus capital and applying a small loss in earnings, does not increase ROE appreciably. In reality, the equity buffer will be required and could only be reduced to some extent. Therefore no real relief there to getting the ROE higher, but the excess capital does reduce risk.

The big changes to come in ROE stem from the group's large on-balance sheet investments. The amounts are not quantified but are in the MAM and the MCap divisions. MQG has invested heavily in infrastructure assets (Green Investments) and is carrying these while it undergoes the development phase and then will realise the assets or use them to fund new funds and then take management fees. Operating expenses are being absorbed as well.  These look as if they are significant. A significant portion is in also data centres and related technology areas. The CEO/CFO made these interesting comments. The Mcap portion of the book is in technology, Government services and Business services companies, the division's historic IRR on investment has been 23% and the group is confident in the outlook for these businesses. The book is reasonably immature having been harvested post-C19 in 2022. The returns will come but timing is unclear as MQG will not sell below FV and will wait for the right opportunities, as they always have. The MAM assets are larger and require the establishment of client funds to sell the assets into. The progress is positive but will take a few years to play out. The Airtrunk sale was unusual having reached maturity quicker than other assets. The CEO stated that all assets have an ROE hurdle applied to them, a low to mid-teens ROE is expected after the assets have been moved off the balance sheet.

A A$1b buyback was completed at $190/share and another $1b was approved.

Valuation

My approach to valuation has been the same for quite some time for MQG. It estimates where equity will be, and what ROE can be achieved on this equity, gives a target EPS and then I apply a multiple. Since this is a smoothed EPS, a normalised PE is used. The next few years will be interesting for the group and we can see what balance sheet restructuring needs to occur. I would look to add around $180-185. The valuation keeps growing over time as it should for all companies adding value.

DYOR—this is not advice and may contain errors.