Morgan Stanley’s Business Model Has The Perfect Mix Of Volatile And Stable Revenue Sources, But Is Underappreciated (And Undervalued)

by Trefis Team
+35.19%
Upside
48.08
Market
65.00
Trefis
MS
Morgan Stanley
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Morgan Stanley (NYSE:MS) reported its results for the first quarter earlier this week, and the investment banking giant exceeded investor expectations by a big margin as it churned out the best ever quarterly income figure in its history. We have summarized Morgan Stanley’s Q1 2018 earnings and also detailed the major takeaways from the announcement in our interactive dashboard for the company, the key parts of which are captured in the charts below.

Notably, Morgan Stanley’s results highlight the bank’s success in putting together a business model which is significantly less volatile compared to its trading-focused model that existed before the downturn, but which is still able to make the most of favorable capital market conditions. In other words, the equal focus on investment banking as well as wealth management has limited the downside risk to Morgan Stanley’s earnings to a great extent while still retaining sizable upside potential. And with the bank’s push into traditional loans-and-deposits services, leveraging the strong presence of its wealth management business, profit margins have also been improving steadily over the years – making the new business model a resounding success.

In view of the better-than-expected profit margins reported by the bank’s investment banking as well as wealth management businesses, we have increased our price estimate for Morgan Stanley’s stock upwards from $60 to $65. The new price estimate is almost 20% ahead of the current market price.

See the full Trefis analysis for Morgan Stanley

Securities Trading Revenues Increased To The Highest Level Since The Downturn

Volatility across capital markets globally increased over February and March this year, after remaining at all-time lows over the second half of 2017 and early 2018. As increased volatility boosted the demand for securities trading services for a quarter where activity is already seasonally elevated, this helped Morgan Stanley’s equity trading revenues jump to almost $2.6 billion for the quarter – the best performance ever for the equity trading desk if we leave out the unusually elevated figures for Q1 and Q3 2008 (in the run-up to the recession). Additionally, the bank’s FICC (fixed income, currency and commodities) trading desk also made $1.9 billion in revenues – the best since Q1 2015. Notably, Morgan Stanley’s total trading revenues were slightly better than that for its trading-focused rival Goldman Sachs.

Wealth Management Margins Continue To Improve As The Bank Adds More Client Assets

Morgan Stanley’s brokerage arm added more client assets over the quarter despite witnessing a sequential decline in total wealth management representatives. Although industry headwinds in the form of lower market valuation led to a marginal decline in total client assets sequentially, the bank did well to keep operating expenses for the quarter in check despite seasonally elevated compensation figures – something that helped margins improve to 26.5%.

Outflows From Money Market Funds Results In Lower Assets Under Management

The industry-wide trend of strong outflows from short-term funds hurt total assets under management (AUM) for Morgan Stanley’s investment management business. Morgan Stanley witnessed outflows of $19.4 billion from its liquidity (money market) funds over the quarter, which coupled with the negative impact of lower market valuation on its asset base, led the AUM figure down to $469 billion from $482 billion at the end of 2017. However, as long-term funds saw steady inflows for the quarter, Morgan Stanley’s revenues for the division increased by 13% sequentially.

We expect Morgan Stanley to report EPS of around $4.75 for full-year 2018. Taken together with a P/E ratio of 13.6 (which we believe is appropriate for the investment banking giant), this works out to a price estimate of $65 for Morgan Stanley’s shares – nearly 20% ahead of the current market price.

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