Canaccord Genuity Group, Inc. (OTCPK:CCORF) Q1 2023 Earnings Conference Call August 5, 2022 8:00 AM ET
Company Participants
Dan Daviau – President and Chief Executive Officer
Don MacFayden – Chief Financial Officer
Conference Call Participants
Jeff Fenwick – Cormark
Stephen Boland – Raymond James
Rob Goff – Echelon
Rasib Bhanji – TD Securities
Operator
Ladies and gentlemen, thank you for standing by. I’d like to welcome everyone to the Canaccord Genuity Group Inc. Fiscal 2023 First Quarter Results Conference Call. [Operator instructions].
I would now like to turn the conference call over to Mr. Dan Daviau, President and CEO. Please go ahead, Mr. Daviau.
Dan Daviau
Thank you, operator, and thanks to everyone for joining us for today’s call. As always, I’m joined by Don MacFayden, our Chief Financial Officer. Following the overview of our first quarter fiscal 2023 results, both Don and I will be pleased to answer questions from analysts and institutional investors.
Today’s remarks are complementary to our earnings release, MD&A and supplementary financials, copies of which have been made available for download on SEDAR or on the Investor Relations section of our website at cgf.com. Within our update, certain reported information has been adjusted to exclude significant items in order to provide a transparent and comparative view of our operating performance. These adjusted items are non-IFRS financial measures. Please refer to our notice regarding forward-looking statements and the description of non-IFRS financial measures that appear in our investor presentation and also in our MD&A.
As widely reported and known to anyone following our industry, financial conditions in our first fiscal quarter have been challenging, driven by geopolitical and macroeconomic factors that have impacted asset prices, market activity and confidence amongst investors and corporates. Despite this, we continue to help our clients achieve their business and financial goals and manage risk.
In addition to the more challenging backdrop, another headwind for this quarter’s results was the impact of sharp declines in the market value of certain inventory and warrant positions earned in respect of our investment banking activities, which primarily impacted our Australian capital markets business and to a lesser degree, our Canadian business. In our Australian business, the rapid deterioration in market values during the quarter translated into a significant decline in our fee-based share and warrant inventory values. On a net basis, this market downturn had a negative impact on revenue of about $20 million in our Australian capital markets business.
The impact of market declines also had a negative impact on revenue in Canada as we recorded facilitation losses of about $11 million, offsetting our commission revenue and fee share inventory adjustments of about $7 million. All our inventories are actively managed, and as such, many physicians were monetized during the quarter. So, we believe that any downside risk associated with these types of holdings in future reporting periods has been reduced.
While the market value of these position moves on a quarter-to-quarter basis, I will note that the quarterly net P&L impact of these positions has historically been positive on average over our holding periods and the impact of these holdings on our overall revenue has not previously been material. Despite this, our platform performed well over the three-month period, giving us confidence in our ability to deliver solid financial results while exceeding our clients’ expectations through the remainder of this downturn.
Our ongoing efforts to increase reoccurring revenue contributions from our expanded wealth management business and grow contributions from capital markets advisory activities are helping to offset the impact of the abrupt decline in new issue activity.
With that, I will turn to the financial highlights of our first fiscal quarter. Firmwide revenue for the three-month period was $328 million on an adjusted basis, down 37% when compared to the same period a year ago. Excluding significant items, pretax net income was $27.5 million, which translated to diluted earnings per share of $0.11.
Turning to expenses. Firmwide non-compensation expenses as a percentage of revenue were elevated at 31% for the fiscal quarter on an adjusted basis, primarily reflecting higher general and administrative expenses in connection with increased travel and promotional activities. These activities were targeted investments in our business development and talent retention efforts, which were concentrated in a short period of time following two years of COVID restrictions. We anticipate more normalized levels going forward.
Adjusted compensation ratio for the quarter was slightly elevated at 60.4%, generally in line with historical rates. As we’ve said before, although our compensation ratio is prone to quarterly fluctuations, we expect it to remain within our targeted range for the full fiscal year, noting that compensation expense will align with revenue levels. Our business continues to be well capitalized, giving us financial flexibility to be opportunistic in this period of dislocation, while upholding our commitment to shareholder returns. Reflecting this confidence our Board of Directors has approved a quarterly common share dividend of $0.085.
Turning to the performance of our operating businesses, I’ll start with wealth management. Although below recent all-time highs, assets in our global wealth management business have remained resilient in light of the significant reversal in global markets. Our investment professionals in all geographies have maintained an unwavering focus on helping our clients navigate uncertainty and achieve their long-term goals.
During the quarter, we experienced net inflows in all our business, bolstered by our acquisition of Punter Southall Wealth, which closed at the end of May. At the end of the fiscal quarter, firmwide client assets were $91 billion, down 4% year-over-year and 6% sequentially, primarily reflecting broad market declines in both equities and fixed income, which offset these net inflows.
On a consolidated basis, this division earned revenue of $162 million and contributed adjusted pretax net income of $25 million for the three-month period. Revenue from our UK and Crown Dependencies business was flat year-over-year at $73 million, but increased by 7% when measured in local currency. We’re having a great experience integrating our recent acquisition of Adam & Co. and PSW, and we are focused on creating additional value through synergies and our organic growth initiatives, which should contribute to margin strength. With the PSW closing midway through the quarter, revenue and net income associated with PSW also will be more wholly reflected in our next fiscal quarter.
Revenue in our Canadian and Australian wealth businesses decreased by 30% and 8%, respectively, largely due to the abrupt decline in new issue activity. Increase in interest rates in both Canada and the UK have positively impacted interest revenue, which increased by 140% year-over-year and will continue to contribute to margin strength going forward. Our focus on supporting investment advisers and their clients, especially through volatile markets, has supported our recruiting and retention efforts. In the last 18 months, we’ve added over $1.6 billion in recruited assets to our Canadian franchise.
The number of advisers in our Australian business has also increased by 5% year-over-year. We are actively considering a range of opportunities to support long-term profitable growth in our Wealth Management businesses globally through new products and capabilities as well as continued support for technology enhancements to keep up with the increasingly complex needs of our valued clients.
Turning to the performance of our capital markets business. Revenue in our global capital markets division was $164 million for the three-month period, down 49% year-over-year, largely due to the abrupt decline in new issue activity and losses in our inventory positions, which offset this revenue. Given the industry slowdown and the diversification away from higher-risk growth assets, I am pleased with the performance of our teams who delivered for our clients and protected our strong market position amongst the lead table leaders in each of our geographies.
During the three-month period, we participated in 80 transactions to raise over $6 billion for corporate issuers. Investment banking revenue for our combined global capital markets business was down 91% year-over-year and 87% sequentially to $12 million. While we earn more in cash fees for our underwriting activities, these amounts reflect a markdown in connection with the impact of previously mentioned inventory positions.
I will note that our Australian capital markets business had an active quarter, completing 29 deals to raise over $1 billion for issuers. While we are disappointed that gains were offset by inventory markdowns, supporting our clients through equity investment is an important part of doing business in this region. I’m very pleased to report that advisory revenue increased 9% year-over-year to $83 million.
Our U.S. and U.K. businesses recorded year-over-year increases of 36% and 59%, respectively. In the U.S., our mid-market TMT advisory team has ranked first for deal volume in both the fiscal quarter and calendar year-to-date. Earlier this week, we announced our acquisition of UK advisory firm Results International, which complements our previous investments to expand our advisory segment and will add domain expertise in the European health care and technology sectors, where we already have strong global capability in both advisory and ECM. We continue to be active globally, and we feel good about the size and quality of our pipeline relative to the market.
In advisory, although market-wide announcements and completions have slowed, we have good visibility into the next six months, and we expect this segment to perform well throughout the fiscal year. Recently, we have seen some green shoots in ECM activity, but our expectation is that we will not see a meaningful recovery in new issue volumes until at least the third quarter of this fiscal year.
Our trading businesses remain well positioned to respond to changes in the market backdrop, and we will continue to provide market-leading execution capabilities for our clients in all businesses and geographies. We expect that economic conditions will continue to tighten before they improve, and we will navigate more volatility and uncertainty alongside our clients. Historically, periods of market dislocation have created opportunities for us to differentiate ourselves and capture new market share.
Heading into our second quarter, activity levels have been similar to Q1, although we will end this quarter with lower expenses and less exposure to market-driven declines in our inventory. In light of the current environment, we are managing our capital and expenses prudently to ensure the best use of our resources for continued balance sheet strength.
Having said that, our long-term strategy does not change. We’re committed to investing in our core capabilities, which have been proven to provide differentiated value for our clients through economic cycles. We will be opportunistic, yet thoughtful in our deployment of capital as we position our business to emerge from this downturn in a stronger competitive position and accelerate long-term value creation for our shareholders.
With that, Don and I will be pleased to take questions. Operator, can you please open the lines.
Question-and-Answer Session
Operator
Thank you, sir. [Operator instructions]. Your first question comes from Jeff Fenwick of Cormark. Please go ahead.
Jeff Fenwick
Hi, good morning, everyone. So Dan, why don’t we talk about capital markets first and just a few things. I think you made some commentary around in your intro there. With respect to Australia, I’m obviously taking some negative marks there that hit the top line. I think you mentioned that there was about $20 million of marks there in the quarter. Is that correct? I’m just trying to get a sense of what the actual sort of like business going on versus some of the markets that you had to take there?
Don MacFayden
Hi, Jeff, it’s Don. Yes, I mean the inventory revaluations during the quarter resulted in a $20 million impact on revenue. It’s just not marks. It’s actually crystallized sales values that were lower than the March mark. And so it shows up as a loss in the quarter – or is the reduction in revenue during the quarter. So the total value has [indiscernible] declined significantly from March to June. So it’s not just mark-to-market, it’s actual sales at lower than the March values.
Jeff Fenwick
Okay. Understood. And I think the comments there where you tried to close that as many as you could so you’re not suffering that going forward. What’s the environment like in Australia now? I mean it’s obviously levered towards mining. Any comments there on the outlook?
Don MacFayden
Yes. I mean it’s early to predict. I mean base metals and gold still hit in the quarter as well as some of the emerging economies got whacked with a strong U.S. dollar. So, we’re cautiously optimistic. This is their busy period. Their summers our winter vice versa, I guess, our summers their winter. We just hosted a big Diggers and Dealers Conference in Western Australia. I think there’s activity. I think it’s premature for me to say, hey, everything is back to normal, but that would be too quick of a statement to make. I mean we’re optimistic over the next couple of quarters that it will come back. But I think the worst of it was last quarter, but I’m not saying this quarter, everything was going to be rosy and back on historical $50 million a quarter run rate. That would be way too optimistic.
Jeff Fenwick
Yes. And I guess I look at it in the past, it was – you used to do like $40 million a year in revenue sort of pre-COVID and then started doing more than that in the quarter. And just trying to get a sense of you built up that…
Don MacFayden
Yes, I think going to be that bad. I mean, the business changed, right? We bought a big wealth business there. We materially expanded our footprint. We hired into our capital markets business. I think we’re probably four – the fourth on the league tables in Australia, like that’s not a place that we were three and four years ago as that business has evolved. So the business is a bigger business than it used to be. That being said, so it’s not 40 a year, but an $840 a quarter either, right, somewhere in between the two. And I wish I can give you a better guidance, but it’s primarily a new issue market there. So, we don’t have as much visibility in that market as we have in some of our others.
Jeff Fenwick
And I guess if you look at the U.S., it was sort of the counterpoint to that to that. I mean, I think it performed quite well in the quarter as you highlighted. And I know advisory’s become such an important part of the business down there. How is that environment looking? I imagine there was probably some things that might have been in process through the quarter that helped you out? I mean, are you going to – I imagine you’re seeing more people press pause in the short term or what’s the environment?
Don MacFayden
Yes. I mean that’s a fear. I don’t think it’s a reality yet. I think a pessimistic person would say, “Hey, when is M&A going to stop? But unlike our new issue business, we do have pretty good visibility on our M&A business. You just know the timetables associated with M&A. So if we’re working on stuff now, that’s revenue in six months. So, we’ve got a pretty good pipeline, a pretty good visibility. I think we’re – again, I keep on using this cautiously optimistic after a bad quarter, but we’re cautiously optimistic that our M&A is pretty resilient at this stage. Ask me again in nine months or six months. But right now, we feel pretty cautiously optimistic on that.
Jeff Fenwick
Okay. And then maybe one on wealth management, specifically with Canada, obviously, seeing the volatility is associated with the level of commission activity in the business there. Maybe give us a sense of how the advisers react to this environment. I think on the capital market side, we all understand the ups and downs and how that works with our compensation. I mean what’s the mood along the advisers with the sort of volatility they’re seeing in terms of the revenue opportunity with their businesses?
Don MacFayden
Great question. I guess it depends on what kind of adviser. I mean we’ve got – majority of our advisers are pure wealth advisers. They earn commission fee and income that’s relatively stable. In fact, if you look at our commission and fee line in our supplemental disclosure, you’ll notice that our commission and fees actually went up in the quarter. What went down in the quarter was the new issue contribution in the wealth business, which we’ve always had, and quite frankly, at roughly $4 million. That’s probably the lowest level I’ve seen in my career. So if you were an adviser that did a lot of new issue business, you were impacted materially. If you were adviser does a lot of wealth management and earns fees and net income, you probably were flat to marginally up in the quarter. So I guess it depends, too.
Jeff Fenwick
Sure. And then maybe just a comment on the recruiting pipeline in Canada. I know you’ve had success in that over the last 18 months. It’s probably a bit of a challenging environment just given the volatility, but what’s the outlook now?
Don MacFayden
It’s about the same as it’s always been, maybe marginally better, which is kind of surprising because typically in down markets, advisers aren’t anxious to uproot and move typically. That being said, the same secular trends that we’ve seen for the last couple of years continue to apply. We continue to hire advisers. Another one will be joining us any day now. So that pipeline, I wouldn’t say it’s stronger or weaker than normal. I think it’s just normal.
Jeff Fenwick
Okay, great. Thanks for that color. I’ll pass the line along.
Don MacFayden
Thanks, Jeff. Great questions.
Operator
Your next question comes from Stephen Boland of Raymond James. Please go ahead.
Stephen Boland
Thanks. One kind of numbers question. Maybe on the facilitation losses in Canada. I mean, I just want to understand that, that is like liquidity that you’re providing to institutional clients on a daily basis to help them out on positions. Is that the typical definition?
Don MacFayden
That is the typical definition of facilitation loss, yes. I would say our losses were concentrated in a smaller number of names. As you could imagine Steve, the business that you were all around here at the box in. So I wouldn’t say, hey, we lost money with 200 clients on 500 names. We probably lost money with 20 clients on five names and making up those numbers, but directionally, just to give you a little bit more color on it.
Stephen Boland
Okay. And has there been any thought on bringing the capital down in that division? And $11 million is material, but has it been thought of actually just shutting a little bit or providing less capital at this point?
Don MacFayden
Yes. I mean the answer is no. That’s the specific answer. But again, if you think of the nature where the business we’re in, Steve, we are a leading mid-market underwriter. We’re not the biggest trader of BCE, Telus and Rogers; we’re the biggest traders of a lot of mid-market names. We need to traffic in those names. That’s not an option. So occasionally, you will take the odd hit in some of these small names and this was – I’ve been doing this for over three decades now. This was a pretty bad quarter from that perspective.
Stephen Boland
Okay. Maybe just on the second in Canada just in terms of advisory fees. When markets tend to come down this sharp and maybe the outlook is overall is not great in terms of the economy and things like that. Have you seen changes in the pipeline in Canada in terms of M&A where firms realize that they may not have access to capital and are actually opening up dialogue with competitors or complementary companies to do M&A?
Don MacFayden
Yes, maybe. It’s – there’s pros and cons of a volatile market on M&A. Obviously, the pros are the ones you alluded to, changes the dynamics, changes access to capital, creates I don’t want to call it desperation M&A, but M&A you have to do, so to speak. And on the other side of that, you’ve got increasing interest rates, you’ve got tightening capital and volatility kills as well as it helps, right? Because it takes so long to get the deal done when everyone’s stock price is 30%, you got to make sure you still have a deal.
So I think it goes both ways. I think the net of the positives and the negatives, it’s about the same. I mean, the environment is about the same. Obviously, we didn’t have a ton of revenue in Canada in our M&A sector this quarter. I think that’s just a timing issue as much as anything else. We just didn’t have a lot of closures this quarter. I think the overall environment is historically where it’s been.
Stephen Boland
Right. Okay. And then one kind of high-level question when you talked about your compensation ratio getting back to your target range. But when I look at your outlook in your MD&A, it’s kind of duller [ph] that threat of recession going up. So how do we marry that? I mean, you kind of said cautiously optimistic, but the MG&A is kind of negative. So I’m trying to figure out what your thoughts are, are things to get worse or it’s slowly better?
Don MacFayden
Fair question, Steve. I would and I’m confused as well. No, I don’t think we ultimately know what’s going to happen here with the market. Obviously, we’ve got at – we’re still – we’ve had a little bit of a dead cat balance in the summer. I don’t think anyone thinks that that’s going to continue on. There is some optimism around later in the year, November, December, things getting much better post midterms, maybe post Fed’s easing. So give a prediction or give a time frame, don’t give both, but things will get better. I’m just not sure when. So maybe that’s the optimism you’re seeing in the numbers.
Your specific question around compensation ratio, though, is we manage to that comp ratio. So obviously, in some of our jurisdictions with some of our people, it will be a tough year. Our biggest – like any other firm like ours, our biggest expense is compensation and most of that is variable. So we’d like to think we can manage within a pretty narrow set of compensation ratio parameters. So we wouldn’t say that we expect our comp ratio to be in line with historical standards unless we were planning on managing to that.
Stephen Boland
Okay. That’s all I have. Thanks very much guys.
Don MacFayden
Thank you so much. And thanks for all your work.
Operator
Your next question comes from Rob Goff of Echelon. Please go ahead.
Rob Goff
Good morning, Dave. And thank you for taking questions.
Don MacFayden
Thank you.
Rob Goff
First, on the advisory side, could you perhaps talk to results, both its UK and European franchise? And any opportunities you see there in terms of cross-selling on your global platform?
Don MacFayden
Yes. Listen, it’s – as, our strategy has been and continues to be to go deeper in verticals that we’re good at, but it’s the easiest way to compete in very competitive markets like the U.S. or the UK. Results is a very good smaller firm that focuses on health care and technology, the two of the sectors that we globally focus on and coordinate on two of our most – well, our two most important sectors, I think it’s fair to say at this stage.
So the interaction not only will be useful from a domestic UK, domestic perspective, adding on additional M&A capabilities in sectors were already strong in the UK. But more importantly, what you’ve alluded to is being able to win cross-border mandates. We tend to be pretty good at that. We’re a small enough firm to be agile, big enough to be global-ish. So yes, there will be an immense amount of interaction between primarily our U.S. M&A practice and our UK M&A practice with the results, we see those businesses interacting well. And we wouldn’t have ventured into the UK, M&A space through an acquisition like Results unless our U.S. team was completely aligned and on site and quite frankly, encouraging that.
Rob Goff
Okay. Do you see yourself pursuing further advisory acquisitions and more broadly on the issue of acquisitions, like we all see the public pains, but have the private market values corrected commensurately with the public or perhaps more deeply?
Don MacFayden
When you ask the private first public question, then I’ll answer your first question in a minute. Are you talking about wealth, are you talking about capital markets or both?
Rob Goff
I was putting it out very broadly, Don.
Don MacFayden
Okay. I’ll give a broad answer then. On further M&A, I mean we’re always looking. But when you buy the M&A boutiques, these aren’t things that, oh, look, this is for sale, let’s buy it. Those guys seem great. There’s a long relationship that goes into any of these things. You’re talking to people sometimes for years, deciding whether this would be a great fit for your organization. So we’re not running around pounding the pavement, trying to find M&A targets in key verticals.
It’s almost needle haystack type stuff, maybe slightly better than that, maybe several needles haystack, but it’s – you’ve got to find the right cultural fit. These aren’t huge acquisitions we’re doing either, as but they’re important. They’re strategic, and they’ve clearly changed the dynamic of our revenue picture and our capital markets business, and you see that specifically in this quarter with the bigger – relatively bigger uptick in M&A. So that’s going on.
Have we seen a change in valuations? I don’t think we’re that active in the market to really be able to say that there’s been a shift in valuations. It’s not like we’re looking at 2022 targets and looking at the pricing of those targets. I suspect pricing will come down, but you say that and then all of a sudden, someone gets sold at a 60% premium to market in the public markets or in the U.S. or in the UK well. So who knows? Public pricing clearly has come down, and that’s obvious but premiums go up. So our valuation matrix is really changing. I’m not so sure, but I’m not sure I have enough data points to answer that really intelligently.
Rob Goff
Very good. I did like your reference to Fed’s easing, something to look forward to.
Don MacFayden
Yes. That would be it for me to miss luck.
Rob Goff
Sorry, what was that? I missed that.
Operator
Your next question comes from Rasib Bhanji of TD Securities. Please go ahead.
Rasib Bhanji
Good morning. Thank you.
Don MacFayden
Hi, Rasib.
Rasib Bhanji
Hey, if I can continue on the acquisition side more on the Wealth Management segment. I think there was some commentary last quarter on some inorganic growth opportunities on the Canadian web platform that you were working on? Is there any update that you can give this quarter? Or is this a longer process for down the road?
Don MacFayden
Yes. I mean, I think we did reference again this quarter that we’re looking at alternative ways and other ways of growing our Canadian wealth business. We’ve got a huge platform here. We think there’s lots of creative ways to grow it. We continue to examine opportunities. Some of them go sideways, some of them go up, some of them will go down, volatile markets don’t help. But yes, no, we continue to explore ways to grow our Canadian wealth platform for sure. I’ve got nothing to announce today and maybe nothing to announce in the next three months, but we continue to explore it. It is a focused area of growth and an area that we will commit more capital to for sure.
Rasib Bhanji
Okay. Makes sense. And then continuing on the wealth management side, there was some commentary in the press release about net inflows for the Canadian and UK businesses. Just wondering if you can provide a number or how material item close has been for these two businesses like relative to previous quarters. Are they still holding in or is there some softness that you’re seeing?
Don MacFayden
Hi, it’s Don. Yes, we don’t provide that – the level of granularity in our AUA or AUM type numbers. But we have seen positive net inflows. And I think it’s consistent with what we’ve been seeing over the course of the last year. It hasn’t really increased or decreased, it’s just steadily on the positive side.
Rasib Bhanji
Okay. All right. Thanks. Just my last question also on wealth management. The increased revenue line item looks like it’s moving in step with rising interest rates, and then we’ve had a few more interest rate hikes after the quarter and then there are expectations for further rate hikes. Would it be fair to say that there’s more upside towards this line item? I think it came at $10 million this quarter.
Don MacFayden
Yes. I think it would be a fair assumption to make that as interest rates go up in our wealth side of our business, we earn more money. The spreads widen and then we earn more money. So again, in our supplemental disclosure, you’ll notice that our interest income in the – in our global wealth business is probably at record quarterly highs even at these rates. So clearly – a and that’s because our assets have grown so materially from where they were two and three and four years ago.
And therefore, cash balances are growing, margin requirements are growing, everything is growing. So yes, I think we had about $10 million in net interest income in our wealth businesses last quarter. That number will continue to increase if interest rates continue to go up.
Rasib Bhanji
Okay. That’s all. Those are all my questions. Thank you.
Don MacFayden
Great, great questions. And thanks for joining.
Operator
Ladies and gentlemen, there are no other questions from the phone lines. This will conclude your conference call for today. We would like to thank everyone for participating and ask you to please disconnect your lines.
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