2023-04-10 10:17:31 ET
Summary
- Morgan Stanley's shares have held up well, after a tougher 2022.
- The bank sees some outflows at its wealth management business which does not bode well for 2023, a difficult year in the making for banks.
- I am fearful of the combination of a softer organic performance and relative share price outperformance, despite a non-demanding valuation.
In December, I concluded that some bumps on the long term road of Morgan Stanley ( MS ) were seen. This came after the firm had seen a more difficult 2022 following a plunge in investment banking revenues and weaker wealth management performance in a difficult year for financial markets.
While this was in part offset by higher interest rate revenues, I failed to see a compelling reason to actively add around the $90 mark, following a peak around the $100 level earlier in 2021.
A Great Transition
Morgan Stanley was among the larger (investment) banks ahead of the 2008 financial crisis as its $80 stock in 2007 plunged to $10 a year later. Following lifelines provided by the Fed and an investment made by Mitsubishi Group, the company stabilized operations and ever since has made an impressive transformation.
The company has moved away from a full-fledged investment bank into a less capital-intensive wealth management business, to an important point the result of the acquisition of the remaining state in Smith Barney, held by Citigroup ( C ) at the time. This was followed by acquisition of Eaton Vance and E*Trade in the years thereafter.
It is exactly such a transition which made the shares appealing in a multi-year turnaround story. This strategy paid off dividends as shares of the bank had risen to the $50 mark pre-pandemic. They rose to the $100 mark in 2021 and early in 2022.
This was driven by strong 2021 results, as released early in 2022, a year in which revenues rose to nearly $60 billion on which a pre-tax operating profit of nearly $20 billion was posted, working down to earnings power of $8 per share.
The revenue composition was pretty much split 50-50 between wealth management and institutional revenues (former investment banking activities) which benefited from a strong IPO, SPAC and M&A market in 2021. The resulting 12-13 times multiple looked cheap but was arguably the result of strong earnings at a good point in the cycle.
This was seen in the 2022 results with revenue declines posted in both segments. Investment banking activities were hit hard by lower activity levels, and wealth management revenues were hurt by lower markdowns and actually some asset outflows. Nonetheless, the resulting $6 per share earnings power worked down to a reasonable 15 times earnings multiple at $90 in December.
Caution Saves The Day
Since voicing a positive but cautious tone in December, shares have risen to the $100 mark earlier this year as the turmoil in the banking sector in recent weeks have meant that shares pulled back to $84 per share here.
In January, the bank posted its results for the year 2022 with revenues down 10% to $53.7 billion, albeit that a fourth quarter number of $12.7 billion was weak, with revenues trending just above the $50 billion mark. As the company only cut costs in a small way, pre-tax profits for the year fell from $19.7 billion to $14.1 billion, with the revenue shortfall almost translating one-on-one to the bottom-line. Earnings for the year still came in at $6.15 per share, albeit that the fourth quarter number of $1.26 per share suggests just a five dollar per share run rate.
The investment bank saw full year sales down from $29.8 billion to $24.4 billion amidst weakness in equity and fixed income underwriting, in part offset by higher fixed income revenues. Wealth management revenues rose by a percent to $24.4 billion, and it did well amidst rocky financial markets, although this conclusion is distorted by higher net interest revenues. The more volatile investment management business posted a decline in sales to $5.4 billion.
Some Underlying Weakness
The reality is that there have been some softer spots within the operating performance. The wealth management business has benefited from higher interest rates during the year, but the underlying quality is softer. Total assets under management or under supervision fell 17% during 2022 from $1.57 trillion to $1.30 trillion, the result of lower asset values and $74 billion in asset outflows, of which more than $24 billion in the fourth quarter alone.
The combination of wealth management and a (investment) bank still results in a rather large balance sheet which is flattish compared to 2021, totaling nearly $1.2 trillion, supported by a relatively modest $67 billion tangible equity position. Contrary to some other banks, it is the nature of the activities which makes Morgan Stanley less susceptible to losses on (investment) securities, not relying as much on a cheap and loyal depositor base.
That said, the gross unrealized losses on available for sale securities and held to maturity securities totals $16.2 billion by year end 2022, largely due to unrealized losses on treasury and agency securities. This is a serious number, but manageable given the profitability of the bank and the large non-deposit based activities of Morgan Stanley. The deposit base is quite stable in part because the bank paid out a 1.5% rate by the end of the fourth quarter already, and while it is not competitive versus the Federal Funds rate, it looks high compared to what other banks are offering their depositors (at the time).
That said, I am a little bit less impressed here with Morgan Stanley following large deposit outflows in the wealth management business in the fourth quarter and throughout 2022. Given this and the unrealized losses, I am surprised that shares held up so well, certainly on a relative basis, which does not make them automatically appealing at current levels.
For further details see:
Morgan Stanley: Some Cautious Thoughts Into 2023