Why Morgan Stanley Stock Could Sink To $27 Again

by Trefis Team
Morgan Stanley
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Having shed more than 20% of its value so far this year, Morgan Stanley’s stock may yet slide some more. Our belief stems from the fact that Morgan Stanley’s (NYSE: MS) revenues will likely be hurt due to a drop in asset valuations and lower commercial & consumer spending, not to mention the higher risk of loan defaults, resulting in lower earnings for the year. Our dashboard How Low Can Morgan Stanley Stock Go provides the key numbers behind our thinking for the drop, and we explain more below.

The point is, a significant contributor to Morgan Stanley’s stock growth over the last two years has been a strong uptick in earnings per share – driven to a great extent by the bank’s multi-billion dollar stock repurchase program. However, Morgan Stanley’s P/E ratio, on a trailing basis, fell from about 15.8x at the end of 2017 to around 9.7x at the end of 2019. The P/E multiple is down to about 7.6x now, which is roughly 22% lower than the P/E figure at the end of 2019. And a sharper-than-expected reduction in earnings could take the multiple lower. Add to this the fact that the stock reached $27 on March 23rd, and there remains a real possibility that Morgan Stanley’s stock sinks to that level again under our downside scenario.


So what’s the likely trigger and timing to this downside?

A potential sell-off in Morgan Stanley’s stock could mark the culmination of growing concern among investors, considering the impact that the outbreak and a broader economic slowdown could have on consumer activity. The banking giant has a sizable portfolio of consumer loans through its wealth management operations, which could lead to sizable loan losses if consumer activity levels fall and the economy heads towards a recession. Further, as the economic condition deteriorates, it could become expensive for the bank to attract funding, negatively impacting its lending operations. Similarly, lower equity market activity and a drop in asset valuations are likely to hurt investment banking as well as investment management revenues.

However, the bank could profit due to its significant presence in the sales & trading business. The company generated around 33% of its revenues from its sales & trading business in 2019. Given the extreme level of volatility in equity & debt markets over recent weeks, the bank is well-positioned to report strong results for its securities trading arm (especially its equity trading desk), which should partially mitigate the negative impact of weak economic conditions on its other operating segments.

While the company’s results for Q1 showed the beginning of these trends, we believe Morgan Stanley’s Q2 results in July will further confirm the hit to its revenue. It is also likely to accompany a lower Q3 as-well-as full-year 2020 guidance. Specifically, we believe the full-year revenue expectations formed by the market at the time of Morgan Stanley’s Q2 results may be closer to $35.2 billion – about 7% lower than its 2017 revenue of $37.9 billion and 15% lower than the 2019 revenue of $41.4 billion. Our dashboard shows key components of Morgan Stanley’s revenues (Base case scenario).

The market isn’t going to stomach this well, and Morgan Stanley’s P/E could shrink further from the current level of 7.6x to 7.0x – which is about 28% lower than the 2019 P/E of 9.7x and the lowest level in the last four years. Also, the 15% reduction in revenues will not accompany a proportional reduction in expenses, as compensation expenses and many cost components like (brokerage, clearing and exchange fees; information processing and communications expenses, etc.) are likely to fall by a smaller percentage – likely resulting in the net income margin shrinking from 20.6% in 2019 to 16.4% in 2020. This, in turn, would mean a double whammy of a roughly 30% reduction in earnings as well as P/E multiple – translating into Morgan Stanley’s price drop of about 35%, to around $26 or lower.

Will such a drop be justified? Absolutely not. However, investors who are first out the door in a panic selling situation take a smaller hit to their portfolio. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.

We do believe these trends are likely to reverse in later quarters of 2020. As the Coronavirus crisis is tamed during late Q2, higher revenue and earnings expectations will replace the dire scenarios that are easily imagined during difficult times. Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture. It complements our analyses of the coronavirus outbreak’s impact on a diverse set of Morgan Stanley’s multinational peers. The complete set of coronavirus impact and timing analyses is available here.

Overall, we believe Morgan Stanley’s stock price at levels of $47 (Trefis price estimate) and below provide a buying opportunity for investors willing to be patient. But if our downside scenario comes true, Morgan Stanley might actually end up doing slightly better than its peers JPMorgan and Citigroup as we highlight in separate dashboards.


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