The last time we covered Macquarie Group (ASX: MQG) was November last year while MQG shares were traded at $130.83. As of the time of writing, the bank is trading above $200 per share which is more than a 54.5% gain since we had recommended MQG. Macquarie has had an incredible run this year, the bank continues to deliver solid results as per its recent half-year of FY22.
Macquarie’s solid first-half results to support further growth
Let us highlight the eight key points of this half-year exceptional performance to have a quick idea of what’s going on before we dive into the details of what to expect in the next few years:
- Terrific net profit: MQG reported a terrific first half of FY22 net profit of $2,043 million, up 107% on the first half of FY21 and in line with the second half of FY21.
- Diversified income growth: MQG’s international income now represents 72% of the group’s total income in the first half of FY22.
- AUM continues to expand: MQG’s Assets under management expanded by 41% to $737 billion during the period.
- Solid financial position: MQG’s Financial position comfortably exceeds regulatory minimum requirements.
- Ample capital reserved: MQG has a group capital surplus of $8.4 billion
- Conservative leverage ratio: Bank CET1 Level 2 ratio 11.7% (Harmonised: 14.8%); Leverage ratio 5.3% (Harmonised: 6.0%); LCR 179%; NSFR 122%.
- Improved Return on Equity: MQG has improved its annualised return on equity to 17.8%, compared with 14.3% in FY21.
- Dividend growth back on track: MQG is providing an interim ordinary dividend of $2.72 per share, 40% franked, representing a payout ratio of 50%.
Macquarie raises $1.5 billion via a non-underwritten institutional placement which will be followed by a non-underwritten share purchase plan
Just last week, Macquarie announced a net profit after tax attributable to ordinary shareholders of $2,043 million for the half-year of FY22, up 107% year-on-year and in line with the $2,030 million net profits for the half-year of FY21.
More importantly, the banking giant also announced that it is seeking to raise $1.5 billion in the form of a non-underwritten institutional placement, which will be followed by a non-underwritten share purchase plan. The capital raising will provide additional flexibility for the company to invest in new opportunities where the expected risk-adjusted returns are attractive while maintaining an appropriate capital surplus.
We have seen during the first half a significant increase in net profit contribution from all four of the company’s operating groups compared with the previous first half, a period which was affected by the COVID-19 pandemic. The recent result is consistent with a strong second half of FY21 and reflects improved trading conditions across the bank’s diverse platform.
About the capital raising, Macquarie has experienced a period of sustained and material growth in capital requirements across its annuity-style and markets-facing activities. Having deployed $5.5 billion of capital over the second half of FY21 and the first half of FY22, the group continues to see a strong pipeline of opportunities.
During the first half of FY22, annuity-style activities, which are undertaken by Macquarie Asset Management (MAM), Banking and Financial Services (BFS) and certain businesses in Commodities and Global Markets (CGM), generated a combined net profit contribution of $2,517 million, up 57% year-on-year and up 47% compared to the second half of FY21. Markets-facing activities, which are undertaken by Macquarie Capital and most businesses in CGM, delivered a combined net profit contribution of $A1,467 million, up 118 per cent on 1H21 and down 31 per cent on 2H21. The company’s net operating income of $7,804 million was up by 41% on 1HFY21 and up 8% year-on-year, whilst operating expenses of $5,069 million were up by 19% on 1HFY21 and up 10% year-on-year.
Income tax expense of $603 million was up from $275 million in 1HFY21 and down from $624 million in 2HFY21. The effective tax rate for the first half of FY22 was 22.8%, up from 21.8% in 1HFY21 and down from 23.5% year-on-year. The higher effective tax rate compared to 1H21 was mainly driven by the geographic composition and nature of earnings.
Macquarie is expanding steadily and as of the end of the first half of FY22, the group employed more than 17 thousand people, which was up by 5% compared to FY21. In addition, over 160 thousand people were employed at assets managed by Macquarie and investments where the company holds significant influence.
Macquarie assets under management were $737 billion at the end of the period, up by 31%. This was primarily due to the acquisition of Waddell & Reed, positive impacts from foreign exchange, investment by Private Markets-managed funds and Public Investments positive net flows along with market movements.
What we really like about Macquarie, is the bank’s large proportion of profit generated by annuity-style activities. Hence, more than 63% is coming from activities that brought steady and predictable cash flows.
Macquarie Asset management or MAM delivered a net profit contribution of $1,305 million, up by 23% from $1,062 million in the first half of FY21. The result was driven by income related to the disposition of Macquarie Infrastructure Corporation assets, partially offset by a gain on sale of Macquarie European Rail in the first half of FY21 and lower performance fees.
The Banking and Financial Services arm or BFS delivered a net profit contribution of $482 million, up by 52% from last year’s $317 million. The result reflected strong home loan, business lending, platforms and deposits growth along with lower credit impairment charges, which were partially offset by increased headcount and investment in technology to support growth.
The Commodities and Global Markets division or CGM brought a net profit contribution of $1,729 million, up by 60% from $1,082 million in the first half of FY21. The result reflects increased revenue across Commodities, with strong risk management income from Gas and Power, Resources, and Agriculture. Commodities inventory management and trading income decreased, with strong trading gains from supply and demand imbalances in Gas and Power more than offset by the unfavourable impact of timing of income recognition on storage contracts and transport agreements. The result also benefited from the partial sale of the UK meters portfolio of assets in May 2021.
And finally, the markets-facing activities, Macquarie Capital produced a net profit contribution of $468 million, up significantly from a loss of $189 million in the first half of FY21. The result reflected higher fee and commission income which was driven by mergers and acquisition and debt capital markets income, partially offset by lower equity capital markets and brokerage income following last year’s strong first half. Investment-related income increased, primarily due to material asset realisations and an increase in the Advisory and Capital Solutions Principal Finance debt portfolio.
On top of an already strong operating performance and balance sheet as we have presented above, Macquarie is recently eyeing off the huge wave of money set to flow into green energy projects as a key source of future profits. Hence, the banking giant tapped shareholders for more than $1.5 billion to fund its expansion. Last week, Macquarie launched the equity raising via an institutional placement. This happened at the right time in our opinion, as the company has delivered record half-year profits which is more than double what the firm made in the same period last year. We are pretty bullish on the growth prospects for Macquarie as the group is benefiting from the market volatility and rising prices for its infrastructure assets, an area where the company is a global leader among the banks. Macquarie has made cashing in on the structural changes required to address climate change a long-term priority. However, the bank has highlighted the importance of shifting its investment towards renewable energy as one of the key long-term business opportunities that would soak up some of the newly raised capital. Alongside its green investment push, Macquarie remains a key player in fossil fuel energy markets, hence, the firm was benefiting from the surge in European gas prices due to increased client demand. Macquarie’s green energy investment is an important step for the bank to “de-risk” its high exposure in the fossil fuel energy markets. Furthermore, green energy represents Macquarie’s pipeline of more than 300 lucrative renewable energy projects.
In our opinion, Macquarie’s capital raising makes quite a lot of sense given the company’s high share price and ongoing growth pipeline, along with the result which revealed strong revenue from fees, trading income and asset sales. Moreover, we could say that the conditions are perfect for the bank right now. Thus, there are low-interest rates, high volatility, and high asset prices. The recent capital raising campaign is consistent with Macquarie’s long-running strategy to focus on green energy investment and targeting infrastructure assets.
The placement was announced last week and it is expected to raise approximately $1.5 billion. The placement price is determined via a bookbuild process, commencing at $190.00 per Placement Share, representing a 4 per cent discount to the last closing price of $197.83 on Thursday, 28 October 2021. The Placement is expected to result in the issue of approximately 7.9 million Placement Shares, representing approximately 2.1% of total existing Macquarie shares on issue. The Placement is within Macquarie’s existing capacity under the ASX Listing Rule 7.1 and therefore no shareholder approval is required to issue the Placement Shares. The Placement Shares settled on Wednesday, 3 November 2021 and were issued and commenced trading on Thursday, 4 November 2021. Placement Shares will rank equally with existing Macquarie ordinary shares and, as they will be allotted before the record date, will be entitled to receive the first half of the FY22 dividend.
Furthermore, Macquarie will offer eligible shareholders the opportunity to participate in a non-underwritten Share Purchase Plan (SPP) with a maximum application size of $30 thousand per eligible shareholder. Eligible shareholders are shareholders with a registered address in Australia or New Zealand on the register as of 7pm on Thursday, 28 October 2021 and who are outside the United States. The size of the Share Purchase Plan will depend upon demand from eligible shareholders. The new shares issued under the Share Purchase Plan will be offered at the lower of the placement price, adjusted for the first half of FY22’s dividend of $2.72 per share, and a 2% discount to the volume-weighted average price of Macquarie share price on an ex-dividend basis during the five trading days immediately before and including the SPP closing date.
FY22 onward Outlook: Macquarie to continue to expand with a cautious approach to capital allocation
We have seen that Macquarie continues to maintain a cautious stance, with a conservative approach to capital, funding and liquidity that so far has positioned the bank well to respond to the current environment.
We have identified four key factors that may influence MQG’s short-term outlook:
- The duration of COVID-19 and the speed of the global economic recovery and extent of government support for economies.
- The market conditions include significant volatility events and the impact of geopolitical events.
- Potential tax or regulatory changes and tax uncertainties.
- The geographic composition of income and the impact of foreign exchange.
Despite these key factors that may weigh on the banking sector, Macquarie has proved to be well-positioned to deliver superior performance in the medium term. This is due to the company’s deep expertise in major markets; strength in business and geographic diversity and ability to adapt the portfolio mix to changing market conditions. Furthermore, MQG has been very good at identifying cost savings through its initiatives and efficient cost savings programme. Once again, during FY21, Macquarie has demonstrated its ability to maintain a strong and conservative balance sheet, along with a proven risk management framework and culture. Hence, Macquarie’s financial position exceeds the Australian Prudential Regulation Authority’s (APRA’s) Basel III regulatory requirements, with a Group capital surplus of $8.4 billion by the end of the financial year. The Bank Group APRA Basel III Common Equity Tier 1 capital ratio was 11.7%, harmonised to 14.8% by the end of FY21. Macquarie’s APRA Leverage Ratio was 5.3%, the Liquidity Coverage Ratio was 179% and the Net Stable Funding Ratio was 122% at the end of FY21. Moreover, the total customer deposits increased to $91.5 billion by the end of the financial year from $84 billion at the end of the second half of FY21. A further $24.4 billion of term funding was raised recently during the first half of FY22 which included $9.5 billion drawn from the Reserve Bank of Australia Term Funding Facility.
The Australian Major Banks’ half-year results in 2021 strongly contrast to those of the last year, signalling a recovery in economic conditions and revitalised consumer confidence, which is great news for Macquarie. However, the return to large profits does mask low underlying growth and stubborn costs.
Australia’s major banks reported a combined cash profit after tax from continuing operations of $13.8 billion, up 62.3% year-on-year. This is driven by the non-recurrence of significant provisions raised in FY20 in anticipation of the expected credit losses from COVID-19 which largely have not eventuated.
What is important to note, is that there is continued downward pressure on interest margins across the banking industry, with the average net interest margin decreasing by 6 basis points from the first half of 2020. This has been driven by lower lending rates and higher holdings of low yielding treasury assets, partially offset by the bottoming out of deposit rates and cheap funding through the Term Funding Facility (TFF). Aggregate loan impairment expense has experienced write-backs in the period resulting in a $109 million benefit as three of the major banking institutions released a portion of the provisioning raised during the height of the COVID-19 pandemic.
The outlook remains positive with stronger than expected economic forecasts and more customers coming off loan payment deferrals. However, there remains some uncertainty over the trajectory of Australia’s recovery and whether this would create a two-speed economy as some sectors continue to struggle post-COVID-19 pandemic. Banks have maintained their focus on a sort of “fortress” balance sheet through the half, with capital ratios substantially above prudential minimum requirements. On average Common Equity Tier 1 (CET1) ratio increased by 105 basis points to 12.4% as the major banks retain a portion of profits and proceeds from divestments. It should be noted that the sector’s capitalisation has not been this strong in recent decades and is a stark contrast to the single-digit ratios observed during the global financial crisis of 2008. The cost-to-income ratios continue to remain stubbornly high, declining from 53.3% in the prior comparative period to 50.2%.
Strong Rebound expected, however, a certain level of uncertainty remains
The increase in net profit and Return on Equity of the big four represents a significant rebound from FY20. Aggregate profits in the first half of FY21 are still below those experienced in the years before the pandemic. Whilst the speed of recovery has been quicker compared to previous cycles, adjustments to key profit and return metrics for COVID-19 related provisions and subsequent writebacks reveal the underlying picture is much more stable. Reported statutory pre-tax profit growth against the first half of FY20 is 45.8%.
The big banks, alongside governments, regulators and central banks have underpinned the financial resilience of the Australian economy over the past year, having quickly mobilised operations to support households and businesses. With March 2021 marking the cessation of support measures, the fallout has been more subdued than initially anticipated as a reported 94% of borrowers that had been provided with deferral packages have returned to full payments. Three of the four Majors wrote back $991 million of the $5.7 billion provisions raised in FY20 because of a more optimistic outlook. The exception was CBA, as their results did not reflect more optimistic trends observed in recent months given their December 2020 release date and recorded an additional $882 million in impairment charges. A level of uncertainty remains as small cohorts of borrowers continue to require assistance. This is most notable within business sectors such as tourism, aviation and office property markets which continue to feel the lingering effects of the pandemic. It is anticipated that non-performing loans will remain elevated until border restrictions ease and vaccinations take effect globally.
In the current low margin environment, the pursuit for earnings growth has shifted towards a cost management agenda. Adjusting for recent notable items such as remediation, regulatory compliance, and strategic write-downs, underlying cost-to-income ratios have remained persistent. Whilst the banks are focused on cost transformation and are making progress in areas, their overall cost efficiency has not improved significantly. The potential for cost reductions through operating model simplification, end-to-end process digitisation and digital disruption remains high.
The Australian economy is showing signs of recovery with the RBA revising forecasts for inflation and economic growth, and for unemployment to continue to fall. The RBA’s commitment to holding interest rates low for an extended period has revitalised housing markets with strong asset price growth experienced in recent months. The sustainability of burgeoning house prices presents potential concerns as wage growth remains subdued, creating affordability risks for households despite low-interest rates. The macro-prudential intervention has been garnering attention given previous mechanisms implemented in 2017 to limit investment and interest-only lending, however, APRA remains reluctant to impose such measures at this time. Looking ahead, the earnings pressures facing the Major banks will continue as low-interest rates put pressure on net interest margins. In this constrained environment where profitability has started to rebound, the challenge will be to balance investors’ ROE and dividend payout expectations, the necessary growth, transformation efforts, and community and customer expectations. Whilst prior period concerns may be partially alleviated with a return to double-digit ROE onward the second half of this year and higher payout ratios, sustainability is now a key question of shareholders.
Macquarie exhibits continuous solid earnings growth
Macquarie’s profit for the half-year ended 30 September 2021 increased significantly from $985 million in the prior corresponding period and increased by 1% from $2,030 million in the prior period.
All the fourth business segments of the banks contributed to a solid first half of FY22 net profit. Hence, the Macquarie Asset Management arm was the main contributor with 33% of the total net profit of the group. This was followed by the market-facing activities and the commodities and global markets that provided 18% and 25%.
- Macquarie Asset Management (MAM): The asset management arm’s operating income for the first half of FY22 was $1,305 million, which is an increase of 23% on PCP. This was contributed by:
- increased other fee and commission income largely due to the disposition fee from Macquarie Infrastructure Corporation (MIC).
- Increased base fees were primarily driven by the acquisition of Waddell & Reed Financial, Inc. (Waddell & Reed), investments made by Private Markets-managed funds and mandates and Public Investments market movements.
- Increased share of net profits from associates and joint ventures, primarily driven by equity accounted income from MIC and increased Macquarie Air Finance income compared to the prior corresponding period, which included the impact of COVID-19.
- Decreased credit and other impairment charges are driven by a reversal of the impairment previously recognised on MAM’s investment in MIC.
- Banking and Financial Services (BFS): Macquarie’s banking and financial services division saw a tremendous improvement as well over the period, with an increase in earnings by 52% on PCP which was contributed by:
- Higher net interest and trading income were driven by volume growth in the loan portfolio and BFS deposits.
- Decreased credit impairment charges are driven by an improvement in expected macroeconomic conditions compared to the prior corresponding period.
- Decreased brokerage, commission, and fee expenses largely due to the cessation of grandfathered commission payments to third party advisors in line with legislation.
- Macquarie Capital: The capital arm of Macquarie did as well as pretty well during the period contributing to an income of $468 million. This was possible as the company brought:
- Higher net income on equity, debt and other investments are driven by higher revenue from asset realisations predominantly in Europe, in the business services and technology sectors.
- Higher fee and commission income due to higher mergers and acquisitions fee income and debt capital markets fee income, partially offset by lower equity capital markets fee income.
- Higher net interest and trading income resulting from growth in the Principal Finance debt portfolio, and lower funding costs compared to the prior corresponding period.
- Higher other income reflecting gains on the sale of green energy projects • Lower operating expenses predominantly driven by lower employment costs.
- Commodities and Global Markets (CGM): The CGM business segment had an incredible performance during this period. Income went up by 60% on PCP to $1,729 million. This was driven by:
- Increased risk management products income reflects strong results across all sectors particularly from Gas and Power, Resources, and Agriculture due to increased client hedging activity and gains associated with management of those exposures because of elevated levels of volatility and price movements in commodity markets.
- Net income on equity, debt and other investments increased significantly , driven by the gain on the partial sale of the UK Meters portfolio of assets, comprising the industrial and commercial portfolio.
- Decreased credit and other impairment charges due to an improvement in expected global macroeconomic conditions.
Macquarie’s net operating income of $7,804 million for the first half of FY22 increased by 41% from $5,519 million in the prior corresponding period. The increase was primarily driven by higher fee and commission income, net interest and trading income, net other operating income and share of net profits from associates and joint ventures. The increased risk management products income was reflected by strong results across all sectors, particularly from Gas and Power, Resources, and Agriculture from the CGM arm of the company. Additionally, operating income was also influenced by growth in the average loan and lease portfolio and expansion in average deposit volumes in Macquarie’s BFS business segment. Macquarie also benefited during the period from the remarkable growth in its Principal Finance debt portfolio from its Macquarie Capital business.
Macquarie’s earnings growth is supporting a strengthened balance sheet. Furthermore, the consolidated financial position of the group was impacted by various factors such as the changes resulting from a combination of business activities, group treasury management initiatives and macroeconomic factors including the depreciation of the Australian dollar against major currencies and the elevated levels of volatility and price movements in commodity markets. During the period, Macquarie’s assets grew by more than 42% on March 31, 2021. The increase in assets was mainly due to:
- Derivative assets of $77.2 billion increased significantly from $20.6 billion as of 31 March 2021 primarily due to an increase in CGM in client trade volumes and mark-to-market movements in the interest rate and foreign exchange products and, in particular, energy markets and commodities. European gas prices increased significantly during the period due to an increase in global demand alongside low storage and supply levels ahead of the European winter.
- Cash and bank balances of $32.2 billion increased by 75% from $18.4 billion (FY21) primarily due to an increase in surplus cash placed on overnight deposits with the Reserve Bank of Australia (RBA)
- Loan assets of $118.4 billion increased by 13% from $105 billion (FY21) primarily due to growth in BFS in its business banking and home loans’ portfolios partially offset by net repayments of loans in the vehicle finance portfolio, and an increase in Macquarie Capital’s principal loan portfolio.
- Margin money and settlement assets of $22.1 billion grew by 53% from $14.4 billion primarily due to higher trade volumes resulting in an increase in margin placed with financial institutions and broker settlement balances in Macquarie’s CGM arm.
- Cash collateralised lending and reverse repurchase agreements of $39.4 billion expanded by 7% from $36.7 billion (FY21) primarily due to an increase in group treasury reverse repurchase agreements in the Non-Bank Group partially offset by a decrease in the Bank Group following changes in the Operating Groups’ funding requirements.
Valuation: the return to dividends growth
Considering the exceptional half of FY22 results, Macquarie has resolved to pay an interim dividend for the half-year ended 30 September 2021 of $2.72 per fully paid ordinary share on the issue on 9 November 2021. The dividend will be 40% franked and paid on 14 December 2021. This represents Macquarie’s return to dividend growth with an estimated dividend yield superior to 3.5%.
As we have witnessed Macquarie’s return to dividend growth, we have based our valuation of the company accordingly with the Discounted Dividend Model, or DDM, taking into consideration an adjusted dividend of $9.54 computed from a required retention ratio of 12.5%. We have used a conservative Discount rate of 7.5% and a perpetuity growth rate of 4.5%. According to the required retention ratio of 12.5% and an adjusted net income of $3,941 million, we have estimated the cash required to be circa $493 million. With an adjusted dividend of $9.54 and an estimated cost of capital of 7.5%, we conclude that Macquarie share price is to be valued at around $332 which could mean that MQG could have more than 64% upside potential.
Key price levels
The key price level to watch is the 50-day moving average which is currently at around $184. This level coincides as well with the ascending trend line from mid-2021 to now. As MQG has been extending its upside quite aggressively, we recommend to our investors remain cautious on a possible pullback to around $190 before MQG resumes its upside momentum. The $185 to $190 price area could be a great opportunity for long-term investors to build up a buy position at a fair price.
The last time we covered Macquarie Group (ASX: MQG) was November last year while MQG shares were traded at $130.83. As of the time of writing, the bank is trading above $200 per share which is more than a 54.5% gain since we had recommended MQG. Macquarie has had an incredible run this year, the bank continues to deliver solid results. On top of that, the Australian economy is showing signs of recovery with the RBA revising forecasts for inflation and economic growth, and for unemployment to continue to fall. The RBA’s commitment to holding interest rates low for an extended period has revitalised housing markets with strong asset price growth experienced in recent months. Along with an accommodative economic environment, Macquarie is also expanding rapidly into green energy projects which is a key to their future profits’ growth. Adding to that, the company is back to its dividend growth. This led us to conclude to an implied MQG fair value of $332 per share which is a +64% upside potential from the current market price over a 1.5-year to 3-year time horizon. Therefore, we are issuing a long-term “Buy” recommendation for MQG.