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Top broker warns Magellan share price will underperform in FY20

Is the golden run in the Magellan Financial Group Ltd (ASX: MFG) coming to an end? At least one top broker believes so even as the stock looks set to close FY19 near its record high.

The MFG share price jumped 0.8% to $51.69 during lunch time trade on the last trading day of the financial year. While the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index gained 7% for the year, the stock has surged 124% over the year and is within striking distance to its $52.38 record high that it hit last week.

Magellan shares are the top performer – leaving its peers far behind. The Australian Foundation Investment Co.Ltd. (ASX: AFI) share price is only a little more than 3% in the black, while the Platinum Asset Management Ltd (ASX: PTM) share price lost nearly 18% of its value in the last 12 months.

Has Magellan’s share price hit a peak?

But Magellan’s high could be as good as it gets for the ASX-listed fund manager after Morgan Stanley downgraded the stock to “underweight” from “equal-weight” as it believes expectations are set too high and points out that Magellan is one of the most expensive traditional asset managers globally.

The downside risk looks significant in the eyes of the broker as it has set its price target at $38 a share.

“While MFG has delivered better flows vs. peers, we think expectations are now too high, with the stock up >100% YTD and on ~24x FY20E P/E [price-earnings],” said the Morgan Stanley.

“We think growth options in retirement products are not certain to succeed, expansion to US is unlikely to accelerate, and business mix remains narrow.”

A better alternative to Magellan

There’s no denying that Magellan is a well-run fund that is attracting more than its fair share of capital from investors. But most of the fund flows are for its two original global funds (or strategies), while some of the flow is going into its newer sustainable strategy.

“This implies more concentration risk, which in our view increases the cost of capital. What’s more, MFG has high leverage to equity markets, where a 10% change has a 12% impact on EPS [earnings per share],” added the broker.

“Given our Australian strategists’ cautious equity market stance, we prefer to own a stock with a more diverse and defensive asset management business.”

The stock it prefers over Magellan is Macquarie Group Ltd (ASX; MQG), and I couldn’t agree more. I held Magellan in my portfolio but have taken profit as I think the risk-reward ratio is no longer favourable.

I also own Macquarie and I think it’s better placed to outperform in FY20 as the stock still looks reasonably cheap as it’s gone nowhere in the current financial year.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited. 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 Scott Phillips.

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