Morgan Stanley's Long-Term Plans Justify $35 Value Despite Legal Setback In Q4
Morgan Stanley ( MS ) had a lot of news to convey to investors along with its performance figures for Q4 2013 last Friday. (( Earnings Release , Morgan Stanley Investor News, Jan 17 2014)) The investment bank unexpectedly set aside $1.2 billion as legal reserves for the period, but also managed to inspire confidence among investors by releasing a strategic update detailing its progress and updated targets on several operating goals. An upward revision in its margin targets, plans to hike dividends and buyback shares and the fact that the bank comfortably beat Q4 earnings expectations, when adjusted for the one-time charge, helped Morgan Stanley's shares gain 4.4% over trading that day. However, the euphoria died out over the weekend once investors had sufficient time to piece together all the information from the bank and the shares slid 2.6% on Tuesday.
It should be noted that while growing legal costs have no doubt been a concern for the financial sector as a whole, their impact is largely expected to linger on for a couple of years at most. The strategic changes to Morgan Stanley's business model, on the other hand, point towards long-term sustainability and growth. So, the overall impact of improved profit targets and soon to be reinstated capital return plan far outweighs the current legal turmoil in our opinion. This is why we revised our price estimate for Morgan Stanley's stock upwards from $32 to $35 .
See our fu ll analysis of M organ Stanley
Shrinking Fixed-Income Business Means Lower RWA, More Dependence On Equities Trading
Unlike its other major competitors in the U.S. - Goldman Sachs, JPMorgan, Citigroup and Bank of America - Morgan Stanley's new business model relies more on equity trading operations than fixed-income operations to generate value, due to a conscious decision by the bank to scale down the latter (see Morgan Stanley Cuts Its Fixed Income Targets As Focus Shifts). This fact is evident from the chart above which shows the relative importance of its equities trading desk as well as it fixed-income trading desk to its total share value.
Morgan Stanley made considerable progress in cutting down its FICC assets over 2013, including the sale of its global oil merchandising unit on its way to a complete exit from the physical commodities business (see Regulator Pressure Causing Goldman, Morgan Stanley To Scale Back Physical Commodities Businesses). The bank intends to continue shrinking the asset base in the unit, with a goal to reduce risk-weighed assets (RWA) in the business from $210 billion at the end of 2013 to under $180 billion by the end of 2015 to achieve a return of equity (RoE) of more than 10% for the operations.
Wealth Management Business To Get Leaner
Morgan Stanley's struggle to eke out profits from its wealth management business is no secret, with the bank unable to break the trend of single-digit margin figures for two long years. But the bank stuck to its decision to completely buy out Citigroup's stake in the Smith Barney operations, with this being the focus of its capital plan each year. Having achieved the self-imposed 17% margin target for the business well before the 2014 deadline in Q4 2012, Morgan Stanley has pushed the envelope each quarter and managed to achieve a record margin figure of 19% for each of the last two quarters. This helped pre-tax profit margins for the division reach 18% for full year 2013 from 12% in 2012.
Morgan Stanley achieved the margin target largely by focusing on cutting costs over the last two years. But going forward, the bank will be focusing on growing revenues to achieve a revised profit margin target between 22% and 25% which it expects to reach by the end of 2015. You can understand how these targets affect the bank's share value by making changes to the chart below.
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