Morgan Stanley reported second-quarter results on Tuesday that mostly beat Wall Street expectations. However, weakness in a single key segment deserves closer scrutiny at the same time as the stock has rebounded from earlier declines. Revenue for the three months ended June 30 rose over 11% year-on-year to $15.02 billion, in keeping with LSEG estimates, beating expectations of $14.3 billion. Earnings per share jumped nearly 47% from the year-ago period to $1.82, beating the $1.65 expected, in keeping with LSEG. Morgan Stanley Why we own the stock: We own Morgan Stanley due to rebound in IPO and M&A activity and growth in asset management, which is delivering more everlasting fee-based income. Additionally, we view the bank’s excess capital as supporting further shareholder returns through buybacks and dividends and as a possibility for added investment in growth. Contenders: Goldman Sachs Club Portfolio Weight: 3.5% Last Purchase: Oct 18, 2023 Start: Jul 12, 2021 Bottom Line It was a fairly strong quarter overall. In addition to revenue and earnings gains, Morgan Stanley delivered better-than-expected results on nearly all key company-wide metrics. These include the efficiency ratio, where lower is best, in addition to return on tangible equity (ROTCE), tangible book value per share, and customary equity tier 1 (CET1) ratio. ROTCE is a very important metric in valuing financial institutions, for instance to find out what multiple to use to tangible book value, which is $42.30 per share. Morgan Stanley’s second-quarter ROTCE of 17.5% beat expectations of 15.7%, in keeping with Bloomberg estimates. The CET1 ratio, alternatively, indicates a financial institution’s ability to return money to shareholders through buybacks and dividend payments. That’s why we’re very happy with the sequential increase from 15.1% to fifteen.2%. In addition, total client assets increased to $7.2 trillion, representing further progress toward management’s goal of reaching $10 trillion over the long run. The star of the show was Morgan Stanley’s Institutional Securities segment, which houses all the firm’s traditional Wall Street businesses. Segment revenue of $6.98 billion far exceeded analyst expectations, and all three major subsegments – investment banking, equity trading and bond trading – also beat consensus. On the conference call, CFO Sharon Yeshaya said the division benefited from the “strength of the integrated investment bank in the U.S. and international markets. Higher activity in Asia contributed to the results.” Unfortunately, leads to each the wealth management and investment management segments fell wanting expectations. Investors pay particular attention to wealth management since it provides a more everlasting, fee-based revenue stream and constructing that business has been a serious focus lately. Weakness in wealth management is why Morgan Stanley shares initially fell on Tuesday morning following the discharge. We then saw shares rebound, only to take one other hit when management commented on the decision by saying, “The third quarter [net interest income] might be driven primarily by the sweeps’ performance, and NII could decline barely within the third quarter.” Sweeps occur when a checking account exceeds a predetermined limit and the excess is “rolled over” into higher-yielding accounts, such as a money market fund. So why is the stock up nearly 1% even though Wealth Management posted a miss and there have been comments that NII in the division could decline again in the current quarter? We believe investors — including us — view this as the bottom of NII. In fact, management said on the conference call discussing momentum in Wealth Management that it believes “NII must be higher heading into next yr.” Now add in the ongoing recovery in investment banking, and we get an investor base willing to put a little more faith in management on weakness in Wealth Management than in the past. The segment’s year-end results are expected to pick up, making for a very strong 2025 setup that’s in focus now as we move into the second half of 2024. The final crux of the matter in understanding why the stock rose on Tuesday: the current odds that Wall Street is placing on former President Donald Trump winning the November election, which investors generally view as a positive for financial deregulation. Those election bets may be driving some of the divergence between the Dow Jones Industrial Average and the Nasdaq on Tuesday. They also help us understand why Morgan Stanley shares were able to turn higher early in the earnings call and hit a new all-time high, even though the stock is off its session highs in afternoon trading. Patience with Morgan Stanley is warranted, although we’ll continue to monitor momentum in wealth management. Results in this segment are likely to improve after the current quarter, and the investment banking recovery still has plenty of room to run, with management noting that the gap continues to grow. Additionally, even at current share prices, we are earning a dividend yield of about 3.4%, while the potential is higher that we will see deregulation in the coming years. For this reason, we are increasing our price target looking to 2025 from $98 to $120. Nevertheless, we are maintaining our rating of 2, which means we would wait for a dip to buy more shares. Segment Commentary: Looking at the Segment Sales section of the earnings table below, institutional securities revenues comfortably beat estimates, driven by better-than-expected results across all sub-segments. Investment banking revenues rose 51% year-over-year, with advisory fees up over 30%, equity underwriting fees up over 56% and fixed income fees up nearly 71% from the same period last year. On the conference call, Chief Financial Officer Yeshaya said the company’s investments in this segment “are starting to take effect as capital markets improve and activity increases. … The previously announced M&A backlog continues to grow, indicating diversification across different sectors.” Equity trading revenues rose 18% year-over-year, reflecting broad-based strength in both major businesses and across different geographies. Fixed income trading revenues rose 16% year-over-year, “driven by higher leads to lending, reflecting strong financing revenues, and in foreign exchange attributable to higher client retention,” the company said in its earnings release. Total expenses for the segment (not shown in the table) rose 6.6% to $4.88 billion, driven by a 3.4% increase in compensation expense and a 9.6% increase in non-compensation expenses. Pretax margin was 29%, up from 17% in the year-ago period. Revenues for Morgan Stanley’s wealth management segment disappointed on weakness across the board. Wealth management revenues rose over 15% from the year-ago period, hitting a new record thanks to higher asset holdings and the impact of positive fee-based asset flows. However, the company raised $36 billion in net new money in the quarter, less than the $57.5 billion Wall Street analysts expected, bringing its year-to-date total to $131 billion. Fee-based inflows were $26 billion, marking the seventh consecutive quarter of over $20 billion. “We are seeing a gradual migration of assets from advisor-led brokerage accounts to fee-based accounts, demonstrating that investments in our client acquisition are paying off,” Yeshaya said. Fee-based assets total over $2 trillion. Transaction revenue decreased 10% on a reported basis, but increased 5% when excluding the impact of mark-to-market valuation of investments related to certain deferred cash-based employee compensation programs. The growth was driven by an increase in equity-related transactions. Net interest income, as previously mentioned, lagged year-over-year, declining over 16%. The reason for the decline was a reduction in average deposits as clients shifted some of their cash in search of higher interest rates. Total expenses for the segment rose less than 1% annually to $4.95 billion. The segment’s pretax margin was 26.8%, slightly below the 27% Wall Street had expected. In particular, Morgan Stanley’s deferred cash-based compensation program was a headwind of about 100 basis points to the pretax margin. The Investment Management segment, by far the smallest of the three, beat expectations on revenue, even as total assets under management fell slightly short. Asset management and related fees rose nearly 6% from the year-ago period as higher average assets under management benefited from increased asset volumes. Performance fees and other income more than tripled, but are still largely insignificant given their size in the context of the overall firm. Total segment expenses rose 4.7% annually to $1.16 billion, with both compensation and non-compensation expenses increasing by mid-single-digit percentage points. Capital Returns Morgan Stanley repurchased 8 million shares in the second quarter at an average purchase price of $95.96 per share. The result is a return of capital to shareholders of $750 million, compared to $1 billion in the first quarter. Given the company’s CET1 ratio of 15.2%, Morgan Stanley has plenty of excess capital to continue investing in growth and returning some to shareholders. (Jim Cramer’s Charitable Trust is long MS. A full list of stocks can be found here.) As a subscriber to CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. After sending a trade alert, Jim waits 45 minutes before buying or selling a stock from his Charitable Trust’s portfolio. When Jim has discussed a stock on TV, he waits 72 hours after the trade alert is issued before executing the trade. THE INVESTING CLUB INFORMATION MENTIONED ABOVE IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY AND OUR DISCLAIMER. NO FIDUCIARY OBLIGATION OR DUTY EXISTS OR IS CREATED BY RECEIVING INFORMATION RELATED TO THE INVESTING CLUB. NO PARTICULAR RESULT OR PROFIT IS GUARANTEED.
In this photo illustration, the logo of E-Trade, Morgan Stanley’s online trading platform, is seen on the company’s website in Chicago, Illinois on May 13, 2024.
Scott Olson |
Morgan Stanley reported second-quarter results on Tuesday that far exceeded Wall Street expectations — although weakness in a key segment warrants closer scrutiny at the same time as the stock shakes off earlier losses.
