No doubt this is a volatile period in global and domestic equity markets. I expect that to continue for the remainder of 2015, which means the right response is to concentrate portfolios in high quality and certainty.
Unfortunately, the presence of extreme volatility almost ensures there isn’t much certainty. That is clearly true at the macroeconomic level, but at the company specific level you can still find some certainty.
Quality not quantity
To my way of thinking, this is the time to reduce the number of stocks in portfolios. It’s a time to let your winners run, or even buy a little more of them. On the other hand, the recent bounce driven by short-covering in low quality, uncertain, cyclical companies is most likely giving you a chance to get out. The key to successful investing remains to let your winners run and be a ruthless cutter of losers. That is particularly so in the current environment. Today I am going to write about a large cap Australian winner that I forecast to continue to be a winner: Macquarie Group (MQG).
I believe Macquarie is a structural growth at a reasonable price stock (SGARP). Structural growth is never outright cheap, but relatively cheap vs. the growthless peers of the S&P/ASX200. In fact, Macquarie is one way of Australian investors actually buying some global growth exposure on the ASX. That alone attracts me to Macquarie: its uniqueness as an offshore earning growth stock with nothing to do with China.
Macquarie is not the freewheeling investment bank of the pre-GFC era. It is now one of the world’s biggest asset managers and its earnings and dividends are far more forecastable. The reduction in earnings volatility has led to Macquarie being more rated like a fund manager than an investment bank. However, the P/E re-rating to global and domestic asset management peers has further to run in the years ahead.
Macquarie is in a consistent earnings upgrade cycle: this is what I describe as structural growth, Macquarie’s FY16 consensus EPS forecast has risen from $4.50 to $5.87 since the beginning of 2015. That’s a +30% upgrade to consensus FY16 EPS growth forecasts in nine months and I think those numbers have further positive revision to come.
More than that
But Macquarie is not just an EPS growth stock, it’s also a rising return on equity (ROE) story. These are most often the most powerful investment stories: not only are earnings growing but ROE is also growing.
Last week, Macquarie embarked on another large scale earnings and ROE enhancing transaction. My fund supported the $400 million institutional capital raising to fund the acquisition, feeling through time this deal will lead to further earnings and ROE enhancement. There is also a share purchase plan (SPP) for eligible shareholders.
The transaction was purchasing the $8.2b Esanda dealer finance portfolio from ANZ. The Esanda portfolio comprises retail and wholesale dealer finance on motor vehicles across Australia and had a book value of $7.8 billion. That $7.8 billion book value is broken into $6.2 billion in retail loans and $1.6 billion in wholesale loans. The transaction lifts Macquarie total leasing book portfolio to $17 billion. Most analysts forecast the deal to add 10cps to EPS in the first year.
However, the post deal EPS upgrade wasn’t the only positive adjustment to consensus Macquarie EPS forecasts. Macquarie also lifted earnings guidance for the 1HFY16 to be 55% higher than the previous corresponding period. Macquarie also guided the 1HFY16 dividend to $1.60 per share (40% franked, 50% payout ratio) and reaffirmed its sustainable dividend payout target range of 60% to 80%. Below are our forecasts and prospective multiples for the years ahead, based off a share price of $80.00.
[1]Macquarie offers earnings growth, dividend growth and ROE growth. It also now sources more than half its earnings from offshore, with an overweight to the US dollar. If I am proven right about my long-term A$/US$ target of 65 US cents, then Macquarie will be a major beneficiary on earnings translation and therefore further earnings and dividend growth.
The transformation
This doesn’t happen, of course, without a strong management team and board. I think there should be no doubt that CEO Nick Moore has transformed Macquarie for the better. There is no better example of this than Macquarie’s ability to raise fresh equity capital ABOVE the prevailing share price because investors, including my fund, believed the deal they were doing was sensible, well priced, and increasing the future growth profile. It was also a smaller equity raising than expected.
To put this in context, other Australian “banks” have been raising fresh equity capital AFTER their share prices have fallen 20% and at deep DISCOUNTS to prevailing share prices. Don’t even start me on the Origin Energy (ORG) debacle or BHP Billiton considering a “hybrid issue” to fund a dividend gap. Pound for pound I think Macquarie has the best medium-term outlook on ANY Australian top 20 stock. It is seeing earnings upgrades in a sea of downgrades. This is a great Australian based global growth exposure. In effect, Macquarie is “exporting Australian superannuation” and generating increase returns on that “exporting.
Over the last few years, I have consistently encouraged you to “lose the home bias” in asset allocation. Whether that was via buying ASX listed US dollar earners, allocating money to a global fund manager, or physically shorting the Australian dollar, it has been my most consistent and correct strategy theme. I’ve even now set up a global fund – that’s how much I believe in the opportunities offshore being greater than domestically for the foreseeable future.
Buying Macquarie shares is one clear way of “losing the home bias”. I believe buying and holding Macquarie shares will continue to be rewarding over the years ahead. It is quite feasible to forecast Macquarie earning EPS of 700c in FY17 and the market paying 14.3x for that EPS stream. That would equate to a $100.00 Macquarie share price in two years’ time.
Let’s see what comes but I for one am backing Macquarie to continue to deliver over the years ahead. Growth and certainty are harder to find by the day: Macquarie offers both.
Disclaimer: The AIM Global High Conviction Fund owns Macquarie shares. The AIM Global High Conviction Fund does business with Macquarie Equities.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.