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At the start of 2018 I noted that Morgan Stanley (NYSE:MS) was growing earnings and was awarded a higher multiple at the same time as well. This came as the traditional full-fledged investment bank was moving into a more stable and less-capital-intensive wealth management business, a well thought out strategy.
Having generally shied away from bank stocks, but liking investment managers, I have been a long-term holder of the shares, believing in the turnaround story for many years now.
Back To 2018
An $80 stock in 2007 saw itself fall into major distress a year later as shares plunged to the $10 mark amidst the global financial recession, and the stock was supported by lifelines provided by the Fed and through an investment made by Mitsubishi Group.
Soon thereafter, the company acquired the Smith Barney stake held by Citigroup (C) in order to plant the seeds to create the wealth management business which the company now thrives upon. With the company transitioning further into wealth management business over time, shares have risen back to the $55 mark early in 2018.
The company generated $38 billion in sales in 2017, up 10% on the year before. The institutional securities business (read the wider investment bank) posted $18.8 billion in revenues, indicating that still half of sales were generated from activities like capital markets, investment banking, research, sales & trading. The unit reported $5.6 billion in operating earnings that year, marking compelling margins.
Wealth management revenues were up 10% to $16.8 billion on which operating profits of $4.3 billion were reported, and investment management revenues were reported at $2.6 billion on which operating earnings of nearly half a billion were reported. The bank reported adjusted earnings of $3.60 per share, translating into a reasonable 15 times earnings multiple.
This looked very reasonable as a passive and 100% pure wealth management business like BlackRock (BLK) was trading around 22 times earnings at the time, yet this was more based on passive investments, while Morgan is more focused on activity. Nonetheless, the overall and long-term outlook remained interesting enough to remain an avid holder of the shares, even as I trimmed a part of my position following strong outperformance seen at the time.
What Happened?
Since early 2018 shares have traded in a $40-$60 range until the start of the pandemic, as shares initially fell amidst the outbreak of Covid-19 and rallied to the $100 mark in 2021. Shares started the year around a high of $110, traded as low as the $70 mark during the sell-off this summer, with shares now back to $92 per share again.
Fast forwarding to the 2021 results, as released earlier this year, the company has seen revenues increase to $59.8 billion, a roughly $11 billion increase from 2020 which was difficult in so many aspects. Pre-tax earnings rose to $19.7 billion, translating into net earnings of $15.0 billion and earnings per share of $8.03 per share, more than doubling from 2018.
Irony is that the continued transition to wealth management has been halted with institutional revenues reported at $29.8 billion, still equal to 50% of sales here after a very strong year driven by IPO, SPAC and M&A activity. With earnings power reported at around $8 per share, and these shares trading at $100, the resulting 12-13 times multiple remains even less-demanding than was the case in 2018. This comes as while shares have risen some 80% since 2018, earnings per share have more than doubled.
So far, 2022 has been a much more difficult year amidst a decline in asset valuations, and lower trading a notably investment banking activity, only in part offset by a positive impact of higher interest rates.
Through the first three quarters of the year Morgan Stanley has reported a 10% decline in sales to $40.9 billion, entirely driven by investment banking revenues being cut in half to $4.3 billion, as the decline in the institutional service segment revenues have been a bit less pronounced. Stable asset management revenues were offset by higher net interest income amidst higher interest rates.
While the company cut compensation expenses, overall non-compensation expenses inched up a bit, resulting in a 22% decline in earnings so far this year, with third quarter earnings down as much as 29% on the back of a 12% decline in sales. This means that earnings are trending at around $6 per share at this point in time, or perhaps coming in as high as $6.50 per share.
Nonetheless, there are some reasons to be worried a bit. While AUM has come down alongside the market, long-term outflows total $20 billion so far this year, quite worrying as it creates a tougher set-up for the coming year.
And Now?
Amidst some impairment to the current earnings power, driven by weaker investment banking sales and some asset outflows, the reality is that Morgan trades at just around 15 times earnings here.
There are many moving parts here and there, as higher interest rates are just starting to contribute to the bottom line, as the decline in activity, notably in investment banking, has hurt the results immediately already.
Higher interest rates should boost earnings results going forward, albeit that there are still many uncertainties in a weakening economic environment, as I am generally constructive on Morgan Stanley, but see no reasons to add aggressively here around the $90 mark.
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