Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q17 Earnings Update
Prev. Edition: 2Q17 Earnings Update, August 22, 2017 (broker material considered till Jul 24, 2017)
Brokers’ Recommendations: Positive: 46.2% (6 firms); Positive: 46.2% (6); Negative: 7.6% (1) Prev. Ed.: 7; 5; 2
Brokers’ Target Price: $51.30 (↑ $4.94 from last edition; 10 firms) Brokers’ Average Expected Return: 1.9%
*Note: Though dated Nov 20, 2017, brokers reports and share price are as of Oct 23, 2017.
A flash update on 3Q17 Earnings was done Oct 17, 2017.
Note: The tables below for Revenues, Margins and Earnings per Share contain fewer brokers’ material than that used in the Valuation table. The additional figures in the Valuation table came from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Morgan Stanley is a global financial services company that has a significant market position in each of its business segments. The company’s customers include corporations, governments, financial institutions and individuals.
Trend of Broker Opinions: Broker sentiment on the stock remained skewed toward the optimistic side, with 46.2% of the firms in the Digest group rating the stock both positive and neutral, and the remaining 7.6% rated it negative. Target prices provided by the firms range from a low of $34.00 to a high of $69.00 per share. The average came in at $51.30, implying a return of 1.9%.
Chief Investment Considerations:
§ Diversified product mix
§ Focus on wealth management operations
§ Strong capital position
§ Improving rate environment
§ Improved capital deployment activities
§ Expense-reduction initiatives
§ Legal uncertainties
§ Dependent on performance of equity markets
§ Trading slump
Positive or equivalent outlook – Six firms or 46.2%: These firms believe that Morgan Stanley is one of the most diversified investment banks in the United States, with a leading position in securities and asset management. Further, they believe that the results over the past few quarters reflect management’s progress in systematically refocusing on the less capital-intensive segments, namely Investment Management and Wealth Management. They expect Morgan Stanley to deliver improved results going forward, given the consistent momentum in its core Institutional Securities franchise, benefits from strong financial market, reduction in RWAs and increased corporate confidence without broader economic support.
Neutral or equivalent outlook – Six firms or 46.2%: These firms believe that results will be moderate in the coming quarters due to uncertain market conditions. They believe that Morgan Stanley’s growth is tied to higher level of market shares, and enhanced profitability in Wealth Management and Investment Management segments. Also, the company’s expense-control initiatives and strategies to improve margin in Wealth Management segment are impressive. Further, enhanced capital deployment activities reflect the company’s solid capital and liquidity positions. However, legal challenges are anticipated to weigh on the stock.
Negative or equivalent outlook – One firm or 7.6%: The firm believes that Morgan Stanley’s dependence on the performance of equity markets remains a major concern. In case of a major pullback, the company’s top-line performance is expected to be hurt significantly.
November 20, 2017
Overview
Founded in 1935 and incorporated under the laws of the State of Delaware in 1981, Morgan Stanley is a leading financial services holding company offering products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. The company is headquartered in New York. With 57,702 employees, Morgan Stanley serves its clients through more than 1,200 offices across nearly 43 countries.
The company’s businesses are divided into three segments:
§ The Institutional Securities (IS) segment (accounting for 50% of net revenue in 2016) includes capital raising, financial advisory services such as advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities, and in related products such as foreign exchange and commodities; benchmark indices and risk-management analytics.
§ The Wealth Management Group (WM) segment (44%) provides brokerage and investment advisory services covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services.
§ The Investment Management (IM) segment (6%) provides global asset management products and services in equity, fixed income, alternative investments that include hedge funds and funds of funds, and merchant banking including real estate, private equity and infrastructure, to institutional and retail clients through proprietary and third-party distribution channels. This segment also engages in investment activities.
More information is available online at http://www.morganstanley.com.
The firms identified the following factors for evaluating the investment merits of Morgan Stanley:
Key Positives / Key Negatives§ Expense-reduction initiatives to boost bottom line
§ Morgan Stanley leads the industry with strong liquidity and cash flow reserves
§ Given the consistent momentum in its core institutional securities franchise, the company is expected to deliver better results in the coming quarters
§ More focus on wealth management operations to bring stability and sustainability to earnings
§ Strong capital position will continue to aid increased capital deployment activities / § Tougher operating environment will keep the financials under pressure
§ Operating expenses are anticipated to remain high owing to continued investment in franchise
Note: Morgan Stanley’s fiscal year ends on Dec 31.
November 20, 2017
Long-Term Growth
According to the firms, Morgan Stanley benefits from a balanced and diversified business model. The company is a formidable competitor in each of its major businesses. Management has progressed well in bolstering liquidity, strengthening capital position and reducing exposure to high-risk legacy assets. In the long term, these firms believe that the company has the potential to realize significant gains in both its institutional and retail franchises.
According to the firms, Morgan Stanley is highly diversified both geographically and product-wise. As a result, it is enjoying top-tier global capital markets franchise and solid long-term international prospects.
Morgan Stanley has been reviewing its geographical footprints and giving emphasis on its institutional client coverage and advisory services. More specifically, the company is reducing its presence in Russia and the Middle East, and redeploying the resources in other centers. Further, in Europe and Asia, the company has been streamlining its footprint, defer expansion plans and exit certain parts of its businesses. All these are expected to drive earnings growth in the future.
Moreover, Morgan Stanley has been realigning its business strategy in order to primarily focus on wealth management operations (particularly outside the U.S.), which is expected to stabilize its earnings going forward. For Asia and the Middle East operations, the company is planning to align wealth management with the Institutional Equities and Investment Banking units. Additionally, for the Latin American Wealth Management business, management plans to move the advisors and clients to the integrated platform that supports U.S.-based clients and further leverage the country’s scale and service spreads. The company is also planning a wide range of strategic alternatives to enhance profitability in the European Wealth Management business.
November 20, 2017
Target Price/Valuation
Provided below is the summary of ratings and valuations as per Zacks Research Digest:
Rating Distribution
Positive / 46.2%↓Neutral / 46.2%↑
Negative / 7.6%↓
Average Target Price / $51.30↑
Maximum Upside from Current Price / 37.0%
Minimum Upside from Current Price / -32.5%
Upside from Current Price / 1.9%
Digest High / $69.00↑
Digest Low / $34.00↑
No. of Analysts with Target Price/Total / 10↓/13↓
Risks to the target price include economic slowdown, further spread widening in investment/high grade credit, the reluctance on the part of retail investors to invest in stocks and bonds, a decrease in the overall level of equity and fixed income underwriting as well as mergers and acquisitions, and an inability to materially improve margins in the IM and WM segments.
Recent Events
On Oct 17, 2017, Morgan Stanley declared 3Q17 results. Impressive performance of the wealth management division and higher investment banking fees drove the company’s earnings of 93 cents per share, which handily outpaced the Zacks Consensus Estimate of 81 cents. The reported figure was 15% above the prior-year quarter.
Higher underwriting fees (up 19%), stable equity trading income and an increase in advisory fees (up 10%) were largely responsible for the significant improvement in earnings. Also, the company’s capital ratios remained strong.
However, as expected, fixed-income, currency and commodities (FICC) income declined (down 21%). Further, lower net interest income and a rise in operating expenses were the undermining factors.
Net income applicable to Morgan Stanley was $1.8 billion, up 12% year over year.
Revenues
Prior to the 3Q17 earnings release, the Digest average revenue growth forecasts were $37,690 million for 2017 and $39,401 million for 2018. Following the 3Q17 earnings release, the Digest average revenue growth forecast increased to $37,775 million for 2017 and decreased to $39,313 million for 2018.
Total Revenues, as compiled by the Zacks Digest, is shown in the table below:
($ in million) / 3Q16A / 2016A / 2Q17A / 3Q17A / 4Q17E / 2017E / 1Q18E / 2018EDigest High / 8,909 / 34,631 / 9,503 / 9,197 / 9,330↓ / 37,775↑ / 39,313↓
Digest Low / 8,909 / 34,631 / 9,503 / 9,197 / 9,330↓ / 37,775↑ / 39,313↓
Digest Avg. / 8,909 / 34,631 / 9,503 / 9,197 / 9,330↓ / 37,775↑ / 39,313↓
Digest Y/Y Growth / 14.7% / -1.5% / 6.7% / 3.2% / 3.4% / 9.1% / 4.1%
Sequential Growth / -2.5% / -3.2% / 1.4%
Note: Blank cells indicate brokers did not provide any estimates.
Net revenues in 3Q17 increased 3% y/y to $9.2 billion.
Revenue Components, as compiled by the Zacks Digest, is shown in the table below:
$ in million / 3Q16A / 2016A / 2Q17A / 3Q17A / 4Q17E / 2017E / 1Q18E / 2018EInvestment Banking / 1,225 / 4,933 / 1,530 / 1,380 / 1,454↑ / 5,909↑ / 6,204↑
Trading / 2,609 / 10,209 / 2,931 / 2,704 / 2,745↑ / 11,615↑ / 11,905↑
Investments / 87 / 160 / 163 / 167 / 50 / 545↑ / 545↑
Principal Transactions / 2,696 / 10,369 / 3,094 / 2,871 / 2,795↑ / 12,160↑ / 12,450↑
Commissions / 991 / 4,109 / 1,027 / 937 / 1,000 / 3,997 / 4,077
Asset mgmt./distrib./admin. fees / 2,686 / 10,697 / 2,902 / 3,026 / 3,056↑ / 11,751↑ / 12,104↑
Servicing and Other non-interest revenue / 308 / 825 / 199 / 200 / 200↓ / 828↓ / 828↓
Net Interest Income / 1,003 / 3,698 / 751 / 783 / 825 / 3,130↓ / 3,650↓
Total Revenue / 8,909 / 34,631 / 9,503 / 9,197 / 9,330↓ / 37,775↑ / 39,313↓
Note: Blank cells indicate brokers did not provide any estimates.
Quarterly Segment Details
Institutional Securities (IS): Net revenues were $4.38 billion, decreasing 4% y/y. The fall was mainly due to lower FICC revenues, partially offset by an increase in underwriting revenues, advisory revenues and equity sales and trading net revenues.
Wealth Management (WM): Net revenues were $4.22 billion, up 9% y/y. The increase reflected higher asset management fees and net interest income, partly offset by lower transactional revenues.
Total client assets were $2.3 trillion at 3Q17 end. Client assets in fee-based accounts were $1 trillion (up 17% y/y), constituting 43% of total client assets. Fee-based asset flows were $15.8 billion, up 17% y/y.
Investment Management (IM): Net revenues were $675 million, up 22% y/y. The rise reflected higher asset management fee revenues and investment revenues.
Outlook
Management expects revenue growth of 3-5% in 2017. Also, net interest income is expected to rise consistently in the upcoming quarters driven by efficient deployment of deposits.
Further, the company affirmed its target of $4 billion yearly revenues from its FICC unit despite its downsizing in the recent years. On the M&A front, pipelines and client dialogs are expected to remain strong.
Management expects equity underwriting activity levels to remain healthy, although near-term issuances could be impacted by macroeconomic uncertainties, geopolitical events and a typical seasonal slowdown.
For the Wealth Management segment, the company projects the stability and trends of last several quarters to continue. For the Investment Management segment, it anticipates asset management fees to remain stable with potential unevenness in the investments line.
Some firms anticipate revenues to increase in the quarters ahead, mainly driven by rebound in asset management revenues, Wealth Management revenue growth and improving interest income.
Please refer to the separately published spreadsheet for additional details and updated forecasts.
Margins
Prior to the 3Q17 earnings release, the Digest average pre-tax margin forecasts were 27.6% and 28.2% for 2017 and 2018, respectively. Following the 3Q17 earnings release, the Digest average pre-tax margin forecast decreased to 27.5% and 28.1% for 2017 and 2018, respectively.
Margins, as compiled by the Zacks Digest, are shown in the table below:
Margin (in %) / 3Q16A / 2016A / 2Q17A / 3Q17A / 4Q17E / 2017E / 1Q18E / 2018EPre-tax margin / 26.7% / 25.5% / 27.8% / 27.0% / 26.3%↑ / 27.5%↓ / 28.1%↓
Net operating margin / 18.3% / 17.7% / 18.9% / 19.4% / 18.1%↑ / 19.2%↑ / 19.4%↑
Efficiency ratio / 73.3% / 74.5% / 72.2% / 73.0% / 73.7%↓ / 72.5%↑ / 71.9%↑
Note: Blank cells indicate brokers did not provide any estimates.
In 3Q17, compensation expenses were $4.17 billion, up 2% y/y. The rise mainly reflected improved revenues. Non-compensation expenses totaled $2.55 billion, up 5% y/y.
The company’s compensation to net revenue ratio was 45%, marginally down from 46% in the prior-year quarter.
Outlook
Morgan Stanley targets compensation to net revenue ratio (under flat rate environment) of 37% or below for Institutional Securities, 56% or below for Wealth Management and 40% or below for Investment Management.
Management set an efficiency ratio target of 74% for 2017, which is based on the assumptions of flat revenues. The company does not expect the flat revenue environment to continue, especially given the ongoing growth initiatives.
Morgan Stanley remains on track for its company-wide initiative called Project Streamline. It will help in reducing expenses by $1 billion by the end of 2017.