Given the market recovery and fundamental growth indicators, we have upgraded our recommendation on Morgan Stanley (MS: 23.4184 -0.0316 -0.13%) to Neutral from Underperform.Morgan Stanley’s first quarter earnings came in at $1.03 per share, substantially better than the Zacks Consensus Estimate of 59 cents. Better-than-expected earnings were aided by robust top-line growth and a dip in interest expenses. Higher levels of market activity helped improve underwriting revenues in investment banking operations. However, these positives were partially offset by increased operating expenses.
Although investment banks are facing industry headwinds globally, Morgan Stanley owns a significant competitive leverage, given a relatively consistent growth momentum in its core Institutional Securities’ franchise following a renewed focus on right-sizing its risk appetite and from selected investments in the areas of equity derivatives, proprietary trading, mortgages and principal investments. Moreover, a high return on earnings, ample liquidity and a healthy balance sheet continue to be significant growth drivers.
Morgan Stanley is highly diversified in terms of footprint and product portfolio, enjoying top-tier global capital markets reputation and solid international prospects in the long term bolstered by the consistency of private clients and asset management units. Further, growth opportunities are expected to open up once the market rebounds to its historical highs.
Morgan Stanley continues to grow inorganically as well. The Mitsubishi UFJ stake may result in a positive for the company and will likely provide stability in the medium to long term.
Alongside, the bank acquired a majority stake in Smith Barney from Citigroup Inc. in May 2009 and merged the operations with its own wealth management division. In order to restructure its investment management division, Morgan Stanley completed the sale of its retail asset management business, including its Van Kampen division, to Invesco Limited in June 2010.The divestment allows Morgan Stanley to unlock good value for its retail asset management business as it will now be able to focus on institutional business such as endowments, sovereign wealth funds, pension plans and central banks, among others.
On the downside, as the global economic environment continues to be more challenging and earnings visibility remains low, cyclical pressures in the weak commercial real estate sector increases concern over the near term and prospects for future returns. This has also resulted in declining assets under management that were $283 billion at December 31, 2009 compared with $300 billion a year ago. The decline reflects net customer outflows in Morgan Stanley’s money market and long-term fixed income fund.
Besides, Morgan Stanley still has a meaningful exposure to Structured Investment Vehicles and Commercial Mortgage-Backed Securities assets, which may lead to future write-downs if current market conditions persist.
Morgan Stanley has experienced intense pricing competition in some of its businesses in recent years. In particular, the ability to execute securities trading electronically on exchanges and through other automated trading markets has increased the pressure on trading commissions. The trend toward direct access to automated electronic markets will likely continue. Thus, competitive pressures are likely to affect future revenue growth prospects as its peers may seek to obtain market share by reducing prices.
Morgan Stanley currently retains its (Hold), implying that the stock is expected to perform in line with the broader U.S. equity market in the near term.The company is facing major headwinds to stay competitive and regain its industry leading position as its growth has been negatively impacted by the after-effects of the financial crisis. However, we believe that the company has the potential to realize the full benefits of its strategic and cost-cutting initiatives, employing new people and inorganic growth initiatives.
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