Macquarie Group is one of the highest profile casualties of the GFC, and is now trading at about a quarter of its peak of $100. Had it not received government backing even that might not have been possible. But according to Merrill Lynch, it is a buy. That is brave — especially with Europe teetering on the brink — but it may also be an indication that some parts of the financial system are stuttering back into life. The arithmetic of Macquarie looks alright, with an earnings multiple below 10 and a 6% dividend yield unfranked. The group also has reasonable diversity of earnings and, of course, a geographic spread. It was at one point a very global company, something that proved not to be all that beneficial when the financial crisis went global.
Merrill sees signs that the company’s problems have bottomed:
“Our analysis of underlying drivers for key divisions suggests market conditions are not swinging earnings momentum up, but we do see signs of basing. A modest pick-up in market share in some segments, together with healthy lending spreads and further cost initiatives, support this view. We maintain our view that annuity-style earnings are not fully captured in the current valuation, which means the capital and / or franchise value in the markets divisions are being ignored.
Trading – set to be better in 2H12
The rising commodity market volatility we have witnessed has traditionally been helpful to Macquarie’s trading income. This could be tempered, however, by the lack of action in US natural gas markets. Demand for structured products is flat.
Brokerage & commission – share loss stops, but pressure on
While Macquarie’s Australian market share trends are recovering from multi-year lows, the industry remains pressured from low volumes and tightening margins.
M&A, advisory & underwriting – still tough, but base formed
While advisory revenues are still well off historical levels, 2H12 is run-rating at a similar level to 1H12 with North America showing better signs. ECM is weak, reflecting industry and franchise challenges, although November was stronger.
Base fees – a favourable mix and stable earnings profile
Base fee income, which increasingly relate to funds management due to Delaware, should be aided by the skew towards fixed income. A resilient 1H12 result, significant cost savings, comfort on Basel III capital, a proposed buy-back, greater visibility on the return and growth potential of the annuitystyle businesses, and valuation appeal in our view all remain catalysts to Buy MQG.
Standard & Poor’s has maintained its A rating, and Morningstar sees this as a postive. It also has a buy:
The retention of the bank credit rating is of more significance than the group downgrade and a major positive given 85% of funding sits within the bank. The bank is also the key operating business with most financial dealings including trading in financial instruments, commodities and derivatives conducted in the bank. While the group downgrade is obviously disappointing, it is not surprising given the current difficult financial market environment and the impact this is having on profitability. The downgrade will certainly have some impact on non-bank funding costs, but we do not expect this to be significant, particularly in the context of overall group earnings and some of the other key earnings swing factors. The majority of the debt funding is long-term with very little maturing over the next two years. The average term at 30 September 2011 was 4.8 years. We make no changes to our forecasts as we consider the impact of any funding cost can be accommodated within our current forecasts. But given the continuation of volatile and difficult market conditions, the risk to our forecasts is to the downside.
Macquarie is trading below Merrill’s book value. The price objective is $33. But of course sentiment is extremely negative on the stock after its fall from grace and in such a bearish market there is no particular reason to rush in. At some point, however, an unloved stock becomes so unloved it is a buy.