Global investment bank Morgan Stanley (NYSE:MS) announced its positive performance figures for the last quarter of 2012 Friday, January 18, leading its share prices to soar by almost 8% over trading that day. ((Q4 2012 Earnings, Morgan Stanley Press Releases, Jan 18 2013)) The star performer for the bank was undoubtedly its Wealth Management business, the erstwhile Smith Barney unit in which Morgan Stanley increased its stake to 65% last September (see Morgan Stanley Smith Barney Gives Way To Morgan Stanley Wealth Management), beating expectations by far to churn out its best ever operating margin of 17% for a pre-tax income of just under $600 million. Equity trading figures also saw a considerable recovery over the quarter – another positive for the bank which is keen on downsizing its fixed-income trading business to free up capital, to comply with stricter regulatory requirements.
In view of the better than expected performance of Morgan Stanley’s wealth management and institutional securities business combined with the relaxation in Basel III capital requirements announced earlier this month (see Basel Committee Softens Stance, Allows More Asset Classes & Relaxes Timeline), we have updated our price estimate for Morgan Stanley’s stock from $19 to $24. We explain the main factors behind this 25% upward revision in the bank’s stock below.
Morgan Stanley Wealth Management Breaks Out Of Its Shell
Morgan Stanley has faced considerable difficulty in integrating its legacy wealth management business with Smith Barney over the recent years – something evident from the single-digit margin figures for the unit represented in the chart above. Late last year, Morgan Stanley CEO James Gorman set a ‘mid-teens’ operating margin target for the business by the end of 2013.
But it looks like the efforts that went into aligning the brokerage with the company’s overall business model paid off earlier than expected with the unit achieving a 17% operating margin for Q4 2012. In comparison, the margin figure was 7% for Q3 2012 and Q4 2011. A steady increase in revenues along with a steady decline in expenses are responsible for the marked improvement with pre-tax income jumping from between $300-$400 million for each quarter over the last two years to $581 million for Q4 2012.
As there were no extraordinary factors that impacted the revenue or expense figures for the period, it would be safe to say that the wealth management business has put its much of problems behind it. This led us to increase our forecast for the unit’s operating margins over the years to come.
The Announced Job Cuts Will Also Pump Up The Investment Bank’s Profits
Earlier this month, Morgan Stanley announced its decision to slash as many as 1,600 jobs across its business with the ax falling hardest on its fixed income operations (see Morgan Stanley’s Plan To Slash Jobs Comes With Significant Upside). The bank also made it clear that most of the job cuts will target high-level employees. As this move implies a reduction in positions that draw considerable salaries and compensations, it will have a significant impact on the bank’s investment banking margins.
It must be mentioned here that the $4.4 billion accounting charge for Morgan Stanley for 2012 is responsible for the investment banking margin figure of -16%, shown in the chart above. This is in comparison to a $3.7 billion accounting benefit for 2011, from a revaluation of its own debt.