Narrow-moat Macquarie’s (ASX: MQG) fiscal 2024 profit fell 32% to $3.5 billion, missing our forecast by 7%. Following earnings the shares dropped more than 2% and are currently screening as fairly valued. 

The largest division, commodities and global markets, recorded a 47% fall in profit following stellar years in fiscal 2022 and 2023. Volatility in gas, oil, and resources prices drove strong client hedging and trading activity. The division’s $3.2 billion profit is still well up on the fiscal 2021 profit of $2.6 billion. Adding products and entering new regions provides a base for earnings growth.

The bigger miss to our forecasts came in asset management, with profit tanking 48% to $1.2 billion, despite a 7% growth in assets under management. Asset management fees were flat, with fewer asset sales compared with last year, the key contributor to earnings weakness.

We also underappreciated upfront costs to develop green energy assets before they are transitioned to funds or sold in later years. In April, Macquarie agreed for one fund to acquire six solar, wind, and energy storage assets. This frees up balance sheet capacity and is recorded as income as Macquarie recoups what it has spent on the assets to date. Demand from investors remains strong, with $22 billion in new equity raised.

We increase our fair value estimate 6% to $185 per share on the time value of money and a modest increase to profit growth longer term. Our fiscal 2025 profit forecast is lowered 9% on a smaller earnings contribution from asset sales, and implies earnings growth of around 16%. Management's short-term guidance by division suggests a return to earnings growth in fiscal 2025 but is vague and contingent on market conditions.

Our longer-term forecasts imply a midcycle return on equity of around 14%. After the drop in fiscal 2024 and recognizing that asset sales create lumpiness, we forecast Macquarie can increase earnings per share by 9% per year.

Business strategy and outlook

Macquarie Group is a global asset manager which spent decades branching out from its Australian investment banking roots. Asset management provides more recurring revenue streams compared with transactional based investment banking, but still carries volatility as base management fees are tied to underlying asset values--primarily fixed income, equities, and infrastructure assets.

Macquarie Asset Management is global asset manager with over $900 billion of assets under management. Specialist capabilities in infrastructure and property management set Macquarie apart from most peers and has been a key source of growth. With established capabilities and investment records, the large asset managers in the space continue to garner the bulk of inflows into the category.

The United States is expected to spend trillions on infrastructure over the next decade, addressing ageing transportation, electricity, schools, and airports. The European Investment Bank has backed over EUR 220 billion of green financing in recent years, with its objective to support EUR 1 trillion this decade. More broadly, Oxford economics estimates over USD 90 trillion of infrastructure investment is required globally by 2040.

Macquarie retains a targeted approach across its investment banking business, not actively seeking to take global players head on. In the Americas and EMEA, Macquarie holds less than 2% share. Macquarie continues to leverage its global expertise and reputation in infrastructure and energy to focus on deals in these markets, with success in the smaller end of the market sometimes underserviced by larger investment banks. It is also more active in advising the private equity space.

The banking and financial services division includes a retail bank (around 5% of Australian home loans) and wealth platform. We expect Macquarie’s strategy to invest in technology to improve both the customer experience and the banks' credit approval processes will continue to deliver above-market loan growth.

Economic moat

Learn more about how to find companies with economic moats. 

We believe Macquarie Group has a narrow economic moat. Most of the group’s operations benefit from intangible assets, with asset management activities also benefiting from switching costs, and investment banking from a network effect.

We do not believe the firm’s Australian banking and financial services business possesses an economic moat (around 20% of group income), but we expect the division to continue to deliver returns close to the group's cost of equity.

The large publicly traded asset managers we cover tend to have economic moats, benefiting from switching costs and intangible assets. Although the switching costs might not be explicitly large, the benefits of switching from one asset manager to another are at times so uncertain that many investors take the path of least resistance and stay where they are. As a result, money that flows into asset-management firms on the back of investment track record tends to stay there.

Investment banking moats are primarily built on the network effect and intangibles. A large distribution platform and extensive web of relationships allow an investment bank to more properly price and place securities. A strong reputation makes it more likely that an investment bank will be selected as a bookrunner, capturing more of the profits from an underwriting deal, and gives the firm an early opportunity to hire top revenue-generating talent.

Macquarie is a different business to the one which entered the global financial crisis. Earnings are much more diversified. Banking and wealth earnings have increased materially, and success in expanding the asset management business (via acquisition and focus on infrastructure) has seen the group become far less capital intensive.

Even within the investment banking slice of earnings though, the group puts a lot less of its own capital at risk now. Pre-GFC a large part of the earnings stream was generated on its own capital by taking 50% to 100% stakes in satellite funds such as Macquarie Airports or Macquarie Communications.

Macquarie is Australia’s largest asset manager, ranking in the top 50 globally. The size and scale of Macquarie’s asset management operations – including investment professionals and distribution staff, the strength of its brands, diversity of its AUM by asset class, and geographic reach provide it with competitive advantages over competitors.

The group continues to drive organic growth by adding new investment teams and products, as well as making acquisitions of specialist asset management teams. The acquisition of Delaware Investments in 2010 doubled Macquarie’s North American AUM and presented an opportunity to increase the product offering to both sets of customers. Generating average returns ahead of its peer group in many categories adds to confidence in future AUM despite the potential for fee pressure in asset classes with more passive low-cost options.

We think competitive advantages are particularly strong within the management of infrastructure and real asset investments. Macquarie is the world’s largest infrastructure asset manager. In addition to already being the largest player in the segment, Macquarie continues to attract the largest share of new investment into the asset class globally according to data from Infrastructure Investor. We believe this reflects the high regard and capacity of the investment team to identify, source and develop assets.

These competitive strengths not only manifest in AUM, but allow Macquarie to charge attractive base and performance fees. We estimate the average base management fee for infrastructure and real assets is 1%, with an additional 20% performance fee.

Switching costs are even stronger than traditional asset managers given these unlisted funds typically have 7-10 year lockup periods. This mitigates the potential for investors to pull funds and force asset divestments which would be detrimental to other investors. Product distribution is heavily weighted toward institutional clients seeking long term maintainable and reliable income streams, including pension funds and life insurance firms.

Longer term, Macquarie is well placed to leverage the surge in demand for global infrastructure as it is a world leader in sourcing, investing and or managing major critical infrastructure and real assets. Normalization of cash rates could be a negative for earnings if asset prices fall and reduce the value of existing assets. The infrastructure asset class has also benefited from investor demand for income in a low cash rate environment, and a change in investor attitude could see money leave the asset class. This headwind could be partially offset by lessening competition for assets though.

Investment banking moats are primarily built upon the network effect and intangibles. Investment banking operations are carried out in the Macquarie Commodities and Global Markets division and Macquarie Capital.

As financial intermediaries, investment banks connect parties on either side of a trade. This matchmaking mechanism, and the network effect created by a large distribution platform and web of relationships, exists in multiple business lines and provides Macquarie a maintainable competitive advantage.

In underwriting, an offering company is likely to hire an investment bank with access to a large collection of interested buy-side and wealth management clients, as it leads to a more efficient pricing outcome. Likewise, investors want relationships with underwriters that can provide allocations of new offerings. In mergers and acquisitions, companies tend to look for advisors that have extensive geographic networks of staff and clients when seeking out a merger partner.

Macquarie is number one or two in most investment banking market segments in Australia, with over 25% market share the groups competes with global players such as UBS, Goldman Sachs, and JP Morgan. In the Americas and EMEA Macquarie holds less than 2% share. Despite being much smaller outside of Australia, Macquarie tends to have a more targeted approach, leveraging its global expertise and reputation in infrastructure and energy to focus on deals in these markets.

Macquarie’s commodities and global markets team is built on thousands of staff which includes logistic experts, petroleum and mining engineers, geologists, meteorologists, data scientists, and quants. Macquarie is the second largest marketer of physical gas in North America and number one futures broker on the Australian Stock Exchange. With over 500 counterparties and hundreds of daily transactions Macquarie benefits from deep insights into supply and demand dynamics. This information feeds into the client offering across financing, financial hedging, research, market analysis and physical execution. This position gives customers confidence they will benefit from the market insights of Macquarie.

Macquarie also generates substantial profits by utilizing its own balance sheet to invest in businesses or construct assets in infrastructure, green and conventional energy, which are then on sold to a third-party. Macquarie does not sell assets once constructed into one of its own funds to avoid potential conflicts of interest between stakeholders.

Macquarie’s bank franchise does not have an economic moat, in our view lacking maintainable cost advantages and switching costs required under Morningstar’s global bank moat framework. Macquarie is a relatively small lender in Australia with around 4% market share of total loans, trailing considerably behind the four majors who collectively have more than 75% share. In mortgages, which account for over 80% of Macquarie’s loan book, its share is better at 5% of the Australian home loan market. Macquarie source a larger share of deposits from business customers and cash management accounts linked to broking and wealth management platforms. Macquarie is similar in size to pure play regional banks Bendigo and Adelaide Bank, and Suncorp, both of which we rate no moat.