Taking a Look at Morgan Stanley

Renewed market appreciation observed in the company's stock

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Jan 30, 2017
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Morgan Stanley (MS, Financial) reported its fourth quarter and full year fiscal 2016 results on Jan. 17.

Morgan Stanley had $34.6 billion in net revenues compared to $35.2 billion the full year prior. Earnings for the $80 billion financial services company delivered $5.5 billion in profits compared to $5.7 billion in profits, delivering a negative 2.9% change. Morgan Stanley was up 2% while the broader Standard & Poor's 500 index was near flat in percent change in the same period.

“Our quarterly results reflect consistent strong performance while our annual results show meaningful earnings growth over 2015. We reported solid results in Sales & Trading and Advisory and record revenues in Wealth Management while managing expenses prudently. We are optimistic about opportunities in 2017 and beyond and remain focused on serving our clients and achieving our strategic objectives.” – James P. Gorman, chairman and CEO

Valuations

According to GuruFocus data, Morgan Stanley had a trailing price-earnings (P/E) ratio of 15 times (industry median 20), price-book (P/B) ratio of 1.2 times (industry median 1.2) and price-sales (P/S) ratio of 2.3 times (industry median 3.6). The company also had trailing dividend yield 1.6% with a 26% payout ratio with 1% share buyback ratio.

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(10-K)

Performance

Morgan Stanley outperformed the broader market in both short- and long-term duration. According to Morningstar data, the financial services company had one- and five-year total returns of 72% and 19% while the broader S&P 500 index had 25% and 14%.

Morgan Stanley

Morgan Stanley is a 92-year-old global financial services firm. Through its subsidiaries and affiliates, Morgan Stanley advises and originates, trades, manages and distributes capital for governments, institutions and individuals.

Morgan Stanley derived 71.3%, or $25 billion, of its sales from the Americas in fiscal 2015, followed by 15.2% from EMEA (Europe, Middle East and Asia) and 13.4% from Asia-Pacific.

Morgan Stanley has three business segments: Institutional Securities, Wealth Management and Investment Management.

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(10-K and Earnings Release, Morgan Stanley)

Institutional Securities

According to Morgan Stanley, Institutional Securities provides investment banking, sales and trading and other services to corporations, governments, financial institutions and high to ultra-high net worth clients.

Investment banking services comprise capital raising and financial advisory services, including services relating to the underwriting of debt, equity and other securities as well as advice on mergers and acquisitions, restructurings, real estate and project finance.

Sales and trading services include sales, financing and market-making activities in equity securities and fixed income products including foreign exchange and commodities as well as prime brokerage services. Other services include corporate lending activities and credit products, investments and research.

In fiscal 2015, the Institutional Securities business grew 6.4% on its sales and contributed 51%, or $18 billion, in total Morgan Stanley sales while delivering a net profit margin 20.6% – highest among the segments.

In fiscal 2016, the segment had a negative 2.8% change to $17.5 billion while having a net profit margin of 20.9%.

Wealth Management

As per its 10-K, Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, market-making activities in fixed income securities, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

In fiscal 2015, the Wealth Management business grew 1.4% and contributed 43%, or $15.1 billion, in total sales while delivering a net profit margin of 13.8%.

In fiscal 2016, the segment grew 1.7% and had a net profit margin of 13.7%.

Investment Management

Investment Management provides a broad range of investment strategies and products that span geographies, asset classes and public and private markets to a diverse group of clients across institutional and intermediary channels.

Institutional clients include defined benefit/defined contribution pensions, foundations, endowments, government entities, sovereign wealth funds, insurance companies, third-party fund sponsors and corporations. Individual clients are serviced through intermediaries including affiliated and nonaffiliated distributors.

Strategies and products comprise traditional asset management including equity, fixed income, liquidity, alternatives and managed futures products as well as merchant banking and real estate investing.

In fiscal 2015, Investment Management services had a negative 14.6% change and contributed $2.3 billion or 6.6% total Morgan Stanley sales. The segment also had a net margin of 14.9%.

In fiscal 2016, Investment Management still delivered negative sales growth of 8.8% and had a net margin of 10.7%.

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(10-K and Earnings Release, Morgan Stanley)

As observed, Morgan Stanley exhibited an overall slowdown in its business in recent times. This was mainly brought about by its negative year over year growth for fiscal 2016 in both the Institutional Securities and Investment Management segments.

The Investment Management segment, which deals with defined pension contributions among other institutions, has been experiencing negative business growth since 2013.

Overall, Morgan Stanley had five-year sales, profit averages and operating margin averages of 2.14%, 5.4% and 14%, according to Morningstar data.

Capital structure

As of December 2016, Morgan Stanley’s common equity tier 1 and tier 1 risk-based capital ratios under advanced approach were 16.8% and 19%.

Tier 1 common capital ratio determines a financial institution’s capital adequacy in so much as to make sure financial institutions have enough money on hand to protect their depositors, according to Investopedia (1). Having 4% to 6% ratio means the bank is adequately capitalized while those under 2%, or critically undercapitalized, cannot pay dividends or management fees.

Read: Tier 1 Common Capital Ratio

Morgan Stanley also provided its figures for both pro forma fully phased-in common equity tier 1 risk-based capital ratio under the advanced approach and proforma fully phased-in supplementary leverage ratio that was15.8% and 6.3% in December.

The U.S. government began requiring financial institutions to calculate and publicly report their corresponding supplementary leverage ratios beginning 2015. The supplementary leverage ratio is the ratio of a banking organization’s tier 1 capital to its total leverage exposure, which includes all on-balance-sheet assets and many off-balance-sheet exposures.

According to Morgan Stanley filings, the supplementary leverage ratio should at least be 5% in order to avoid limitations on capital distributions including dividends and stock repurchases and discretionary bonus payments to executive officers.

In review, Morgan Stanley had a supplementary leverage ratio of 6.3% in December 2016 compared to 5.8% in December 2015.

Cash, debt and book value

As of September, Morgan Stanley had $42.6 billion in cash and cash equivalents and $164.8 billion in debt having a debt-equity ratio of 2.14 times compared to 2.16 times the year prior, according to Morningstar data.

For that period, Morgan Stanley also had 1.1% of $813.9 billion assets in goodwill and intangibles while having a book value of $77.1 billion compared to $75.3 billion in September 2015.

Cash flow

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(September 10-Q Filing, Morgan Stanley)

In review, Morgan Stanley had $7.8 billion in cash flow from operations compared to the year prior as of nine months operation that ended in September 2016. Despite the lower profits recorded by the company for the period, Morgan Stanley had more cash flow coming in from securities borrowed and securities sold under agreements to repurchase.

Capital expenditures or money spent related to property, equipment and software were $941 for the period leaving Morgan Stanley with $6.9 billion in free cash flow compared to a negative $8.9 billion the year prior.

The firm also allocated 61.4%, or $4.2 billion, of its free cash flow in shareholder payouts, such as dividends and share repurchases. On average, Morgan Stanley allocated 629% of its free cash flow in shareholder payouts in the past three years.

For the full year 2016, meanwhile, Morgan Stanley stated that it repurchased $3.5 billion of its common stock compared to $2.1 billion in 2015.

Further, Morgan Stanley allocates a good amount of cash flow in purchases of investment securities. Nine months into fiscal 2016, Morgan Stanley purchased $41.2 billion compared to $32.1 billion the year prior. The firm also received $34.9 billion in proceeds from investment securities sales and maturities.

Morgan Stanley also issued $27.5 billion in debt while paying down $28.8 billion in borrowings, derivatives, deposits and other secured financings.

Conclusion

As observed, Morgan Stanley demonstrated a well-capitalized structure with capabilities of providing dividends and stock repurchases to its shareholders as regulated by the government. The firm was able to improve its leverage ratio on a year-on-year basis accordingly.

Given its corporate structure, Morgan Stanley’s balance sheet appeared to be leveraged while the firm’s shares traded at a slight premium, 1.2 times, its book value. The firm also allocates a good amount of its cash flow to its shareholders on a yearly basis.

Meanwhile, slowdown in Morgan Stanley’s top-line growth was also observed.

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(Morgan Stanley share price at $42.6 a share with a trailing P/E ratio of 14.6 times; GuruFocus)

More than a week ago, analysts in Societe Generale improved their rating on Morgan Stanley’s shares to buy recommendation from sell while Barclays reiterated an equal weight rating while increasing its target price to $48 per share from $35.

Using three-year historical earnings multiple and profit growth rates accompanied by a 20% margin, Morgan Stanley had a value of $42 per share (2).

Given the renewed appreciation by the market on Morgan Stanley’s shares and the latter’s recent business performance, investors should take a pass.

*Earlier version of article stated Morgan Stanley reported its earnings results last week.

Notes

(1) Investopedia:

Tier 1 capital ratio is calculated by dividing a financial institution’s tier 1 common capital by its risk-weighted assets.

Regulators rank banks as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.

(2) Three-year multiple of 17 times and profit growth rate of 3.6%.

Disclosure: I do not have shares in any of the companies mentioned.

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