Macquarie Group Ltd says short-term challenges over potential regulatory changes

Credit: Paul Ritz

Shares in Macquarie Group Ltd (ASX: MQG) climbed more than 2 per cent this morning after the investment bank confirmed it expects financial year (FY) 2017 profits to be roughly in line with FY2016’s record result.

The bank’s financial year runs to March 31 and it provided a Q1 FY2017 update at its AGM today to advise that its buy-side asset management business and main earnings driver Macquarie Asset Management continues to perform well as it benefits from higher base fees. Its Banking and Financial Services business also also experienced “growth in mortgages, business banking and deposit books during the quarter”.

The lowlight was a subdued performance from Macquarie Securities the sell-side business highly leveraged to the overall ebullience of capital markets and traders across the Asia Pacific. It is expected to deliver a result down on the prior corresponding period.

Macquarie Capital the advisory and deal structuring business also suffered a subdued quarter on the back of flat markets. In Australia this business once again ranked number one in FY 2016 for M&A and capital raising / deal making work as the bank enjoys a competitive advantage here as a big fish in a small investment banking pond. While, in North America for example the giant US investment banks are ferociously competitive, which is why Macquarie likes to specialise in more niche work overseas across its entire group such as commodities trading, infrastructure asset management or asset lease financing.

The overall result is down on the prior corresponding quarter, but up on what was a soft quarter ending March 31 2016. The start of the calendar year dominated as it was by by worries over a sharp slowdown in China that fuelled precipitous falls in commodity prices and equity markets.

Despite a weak final quarter to FY 2016 Macquarie reported a record-breaking full year profit of $2.06 billion and delivered investors a full year dividend of $4 per share on $6.19 in earnings per share on a payout ratio of 66%.

Today’s news that it’s tracking to repeat this performance in FY 2017 suggests the shares are good value at $75 on 12x earnings with a partially franked yield of 5.3%.

Unlike domestic favourites such as Commonwealth Bank of Australia (ASX: CBA), Macquarie also offers investors exposure to a strengthening US dollar and economy with a market-thumping track record thanks to its agility in adapting to the macro-economic realities in which it operates. The bank has increased its emphasis on annuity-style earnings ever since the GFC and is now commonly described as an asset manager that also does investment banking.

The stock looks good value to me for investors with a long-term horizon and I expect it could marginally beat FY 2016’s result. The key risk it faces is tougher capital adequacy requirements via potential Basel IV reforms as inter-governmental political pressure continues to be exerted on banking regulators to toughen up on global banks.

Higher capital requirements would reduce Macquarie’s all-important return on equity and in today’s update the bank specifically acknowledged its short-term outlook is challenged by “potential regulatory changes’. This looks the key short-term risk for investors to watch.

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Motley Fool contributor Tom Richardson owns shares of Macquarie Group Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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