Morgan Stanley: Murky Outlook (NYSE:MS)

Morgan Stanley (NYSE:MS) is a bank stock that we loved as a top pick in 2020, when shares were under $50. Shares since have doubled. Of course, 2022 saw some pain for stocks, but the banks have largely rallied in the last three months off the lows in October. Today shares are surging, and we think there could be more in the tank, but we need to get through earnings season to make sure there is not a rug pull on this market. If there is, we would be strong buyers of MS stock in the $80s again.

Why? Well, the company just put out a strong Q4 earnings report. We expect some choppy trading in the coming months for the overall market. We think that this will allow you to get shares lower, even after this big pop following earnings. The setup for banks is strong over the next few years, though we are favoring more traditional style banks over investment banking right now. Still, we think the stock moves higher beyond 2023. It is our opinion that traditional banking strength will continue for a few years on the back of higher interest rates, and we also believe recession will be rather tame. Investment banking has been excellent in the last two years-plus, with market volatility following COVID-19 and then a near-zero rate environment, and again as rates started to ramp. After the run, we think you hold. But if the market cools and takes Morgan Stanley’s stock back to the $80’s, start buying. Let us discuss the earnings.

Headline numbers strong

We were pretty unsure of how bank earnings would look this quarter, but we expected investment banking would continue to perform well, but not as strong as traditional banking. We think the latter simply will do better in a higher-rate environment, whereas investment banking and trading tends to thrive in a volatile market, in our opinion. Morgan Stanley reported net revenues of $12.7 billion in Q4. This was decent outperformance, which we simply had not expected (until seeing other bank reports that came before MS last week). However, as expected, revenues were down from last year. In fact, this was a 12% decrease from last year’s quarter.

While a slight decrease was expected on our end and by analysts, we were looking for $12.3-$12.4 billion. We thought that was a good target due to reduced interest in the stock market and reduced volumes of trading, though, and we felt analysts were conservative in their expectations. Well, year over year, the increase beat consensus analysts’ consensus by $0.1 billion. The top-line beat was a driver of strength, but expense growth offset this. While there was solid revenue performance, we saw increases in loan loss provisions which weighed. Simply put, banks are prepping for recession and preparing for losses.

Margins were strong despite increased operational expenses in the quarter. Consolidated pre-tax margins were in the high 20% range. The top line being down with respectable margins led to a decline in net income to $2.2 billion, or $1.16 per share compared with net income of $2.7 billion, or $2.01 per share, last year. Making adjustments, EPS hit $1.31 vs $2.08 last year. The business segments shed some light on strengths and weaknesses to be aware of.

Deeper look at each segment

Once again, Morgan Stanley is an investment-style bank. So, trading activity is a major driver of Morgan Stanley’s results, and the bank tends to do well when there is volatility and a lot of people trading. There were some interesting patterns in the divisions. The “Institutional Securities” segment saw a huge drop-off in revenues vs. last year. The reported revenues of $4.8 billion were down nearly $2 billion from last year, down from $6.7 billion. Ouch. Advisory revenues were down big time due to much lower merger and acquisition activity. Underwriting is also down. Bottom line? There are very few IPOs ongoing and little in the way of mergers.

Over in “Investment Management,” revenues were down $300 million from a year ago. They came in at $1.46 billion, versus $1.75 billion a year ago. This was driven by lower asset management feeds and declines in the equity markets. Performance-based revenues were also down.

Over in the “Wealth Management” side of the business, there was a slight increase. The segment reported net revenues for the current quarter of $6.6 billion compared with $6.3 billion from a year ago. Pre-tax income of $1.8 translated to a pre-tax margin of 29.2%. By far, this was the best performing segment.

As we look ahead, we expect this pattern to continue. If the market can attract money that is on the sidelines, we could see a big push in the other segments. The main problem is that new businesses are not coming public. Venture capital deals are down. Mergers are down. Markets have been weak. We think if we get a big Q1 selloff, it would be to the bank’s advantages, as the next bull market is likely to emerge in late 2023. For now, investors should let Morgan Stanley stock come back down.

Efficiency of the bank

When analyzing banks, the efficiency ratio is important to watch. We continue to argue that the strongest banks have an efficiency ratio under 60%. Morgan Stanley’s efficiency ratio, in part because of their operations as more of an investment bank, has consistently had efficiency ratios above 70%, with some stronger periods in the high 60% range. That said, the bank saw a huge decline in efficiency. Here in Q4 it came in at 76%, well above where it was a year ago at 65%. In fact, in 2022, the efficiency ratio slowly worsened. The full year efficiency ratio was 72%, about in line with historical norms.

Dividend pays nicely

The bank has continued to raise its dividend. Now the dividend is up to $0.775 per share each quarter. This level was maintained once again, as this morning the bank announced this $0.775 per share would be paid in February. With the present share price, the forward yield is now 3.3%. While this is not high-yield by any means, you are paid to wait for the next run higher. What we think is important is that the dividend itself has grown every year since we began following the name. We expect the dividend growth to continue moving forward.

Take home

Morgan Stanley earnings were better than expected. This year, 2023, may be tough on investment banking in general. This is a difficult market environment. Morgan Stanley revenues are down, but rising in Wealth Management which saw record revenues. If the IPO market picks up, or market interest as whole picks up, Morgan Stanley could do very well.