A key objective of the Switzer Dividend Growth Fund is to provide a growing stream of income, maximising franking where possible, and long-term capital growth by investing in a portfolio of blue-chip Australian shares. The Fund has a yield* of 7.5% (9.8% including franking).

As such, we look for stocks with stable cash flows and a history of consistent dividends.

In this mid-monthly update, I would like to present a stock we hold in the SWTZ portfolio that reflects this investment philosophy, Macquarie Group.

* Yield calculation based on distributions paid during the 12-months to 30 June 2019 relative to the closing unit price at the beginning of the period.

Stock in focus: Macquarie Group (ASX:MQG)

MQG is an Aussie success story on a global stage providing financial services around the world.

The success of MQG has been driven by three strong disciplines. These are:

1. a relentless focus on risk control across the group,
2. an innovative business building culture, and
3. a stable wealth sharing structure.

Source: Macquarie Group Limited

The first of these disciplines was demonstrated recently, as MQG remained relatively unscathed while the Royal Commission cut a swathe through most wealth managers. Over the last few years, MQG had identified and managed associated risks in this part of their business. During the GFC MQG, almost alone amongst their investment bank peers, avoided the value destruction caused by poor risk controls.

Secondly, MQG been prepared to back new ventures with capital whilst at the same time maintaining tight risk controls. Capital has been allocated to successful businesses and the group has been ruthless in cutting business that don’t hold promise or fail to deliver.

Over time the structure of the group has slowly changed as new, successful businesses take over from those more mature operations. There are numerous examples of this, but one that stands out is the growth of the infrastructure business which has become amongst the largest in the world.

Source: Macquarie Group Limited

Culture

Thirdly, MQG has incentive and retention schemes in place that has led to a focus on long term returns to the benefit of shareholders. Balancing the division of profits between staff and shareholders always involves a degree of tension, but a successful resolution that benefits all is critical to a stable and growing company. MQG has a long record of delivering good returns for shareholders, retaining skilled staff and profitably growing the company. Prior to the most recent appointment, the last three MQG CEOs have had an average tenure of over 10 years. This is an outstanding result in our view.

Financials

MQG’s focus on risk control extends to its financials as well. MQG’s balance sheet is solid and it usually carries a healthy capital buffer. The business is a mix of annuity businesses, such as funds management, and more volatile market facing businesses, like commodities trading.

MQG also has a significant amount of its profitability being derived from asset sales and performance fees. The difficulty in accurately forecasting these last two items can lead to uncertainty over time in the profit profile. The group is also partly dependent on healthy financial markets and asset values. These lead to short term gyrations in the share price which presents opportunities.
MQG has a Price to Earnings (PE) Ratio of 14.3X and a net yield of 4.6%, or 5.4% grossed up for franking. MQG trades at 2.3X Book Value and has a Return on Equity (ROE) of 16.5%.

Source: Macquarie Group Limited

The PE ratio and dividend yield are relatively attractive. In part this implies the market consensus view that MQG’s profitability (ROE) is near peak levels and a slower growth profile is now expected. MQG’s guidance, which is usually conservative, is for a slightly lower FY20 result.

Summary

MQG has a tremendous track record built on the factors described in this note. The dividend profile over the long term has been attractive. While there may be short term issues with market volatility from time to time, the underlying business remains favorable.