Macquarie Group: Waddell & Reed acqusition scales Wealth Management
ASX: MQG
Market cap: A$56.6BN
Share price: A$158.45
52-week range: A$93.62 / A$158.50
Dividend yield: 2.0% (40% Franked)
Last time we wrote about Sydney-based Macquarie Group (2 July 2020), it was in the thick of the pandemic. Ten months later, the share has more than doubled off its March 2020 low and is trading near an all-time high. We think the rally can go on as the group asserts its financial strength in an improving global banking environment. This is a company that has delivered profits for 51 consecutive years. Not even the unprecedented challenges of COVID-19 could bring this streak to an end—and it wouldn't be surprising to see it continue for another 50 years.
Annuity-style businesses = consistent profits Macquarie Group is a well-diversified investment bank in several ways. It offers advisory, banking, investment and asset management services to an increasingly global customer base. Way back in FY98, international income accounted for 22% of total income; in FY20 it was two-thirds of total income. The group's strength lies in providing commercial banking services to the agriculture, commodity, energy, infrastructure and resource sectors and supporting the M&A needs of large institutions. A big part of why Macquarie was able to extend its profitability streak in FY20 is that more than 60% of net profits were derived from annuity-style activities. The rest of the profits come from market-facing activities. It's hard not to like a business model like this and easy to see why the bottom-line performance has been so consistent. Global asset management, although a smaller part of the mix, has quickly joined the ranks of the 50 largest such businesses in the world with $556bn in funds under management (FUM). Also a small slice of the Macquarie revenue pie is the retail banking business. Even though is a relatively minor part of the business, Macquarie's retail bank is still on the heels of Australia's big four banks in fifth position. We like the diversification that the funds management and retail businesses bring to the firm and see room for growth in both. Waddell & Reed buyout The 1HY21 result reflected mixed trading conditions in Macquarie's operating groups, particularly in 1Q21. The Macquarie Capital business suffered an 8% net loss as infrastructure and energy project construction activity slowed due to COVID-19 restrictions. All other businesses made positive contributions to net profits. Overall, however, profit fell 32% to $985m. The result was dragged down by subdued commercial client activity, reduced M&A activity and higher credit impairment charges. Profits were also lower compared to 1HY20 in banking because of COVID-19 costs to support clients and margin compression, but this was partially offset by strong home loan and deposits growth. Overall, it was a decent start to FY21 considering all but one business unit were profitable, and the balance sheet strength was maintained. The bigger news in CY20 came on 3 December 2020 when Macquarie Group announced the acquisition of U.S. asset management firm Waddell & Reed Financial for $2.3bn. Waddell & Reed has assets under management (AUM) of approximately US$131bn between its asset management and wealth management businesses combined. There won't be a need to spend much time on the welcome party though, because Macquarie plans to turn around and sell the wealth management portion of Waddell & Reed to US-based LPL Financial Holdings for US$300m. Why not just buy the asset management business? Well, Macquarie will still be partnering with LPL Financial (the largest independent broker-dealer in the U.S.) to provide continuity for existing wealth management clients and open doors to new growth opportunities longer term. The deal, which is expected to close later this year, is a good one in our view as it will enhance Macquarie's wealth and asset management platforms and further diversify the market-facing side of the business.More recently, Macquarie's Commodities and Global Markets (CGM) business was thrust into the world spotlight following the extreme winter weather events in Texas and other parts of the United States. The deep freeze conditions led to hyper demand for Macquarie's services to maintain gas and power supplies. The CGM unit ships gas on most of the major US pipelines and since it has built up capacity over time, was leaned on heavily to fulfill the unexpected customer demand. This windfall should provide a nice boost to the tail end of the FY21 period which ends 31 March 2021. Last month management said it expects the FY21 group result to be up 5% to 10%. Premium price is right Macquarie has historically been in good financial health and that hasn't changed throughout the pandemic. It has a common equity tier 1 (CET1) ratio of 13.5% that is well above the 7% minimum regulatory requirement and the 5.9% leverage ratio is almost twice the Basel III minimum. The group's strong capital position along with robust demand for commercial and investment banking should support its ability to deliver growth, especially in the key Asia-Pacific market. In the meantime, the near-term performance will continue to be impacted by the ongoing pandemic uncertainty, government economic support and the speed at which the group can complete its transactions. At a P/E of 19.1x for FY22, Macquarie's stock isn't the bargain it was a year ago and it trades at a premium to peers. But we believe the group has certainly earned the premium valuation. Since listing on the ASX in 2007, Macquarie's earnings have grown at an 11% rate on average as have dividends per share. No other diversified financial company has had a better track record in that period. So, we don't mind paying up a bit for Macquarie, nor do we mind giving it four stars.
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