We’re hiking our price target on Morgan Stanley despite a miss in a key business
Morgan Stanley on Tuesday reported second-quarter results that largely exceeded Wall Street expectations — though weakness in one key segment warrants closer monitoring even as the stock shook off earlier declines. Revenue for the three months ended June 30 increased over 11% year over year to $15.02 billion, outpacing expectations of $14.3 billion, according to estimates compiled by LSEG. Earnings per share jumped nearly 47% versus the year-ago period to $1.82, exceeding the $1.65 expected, according to LSEG. Morgan Stanley Why we own it : We own Morgan Stanley for the rebound taking place in IPO and M & A activity along with growth in wealth management, which provides more durable fee-based revenues. We also view the bank’s excess capital as supportive of further shareholder returns via buybacks and dividends while also providing for additional investments in growth. Competitors : Goldman Sachs Weight in Club portfolio : 3.5% Most recent buy : Oct. 18, 2023 Initiated : July 12, 2021 Bottom line This was an overall pretty strong quarter. In addition to the revenue and earnings beats, Morgan Stanley put up better-than-expected results on nearly all key firmwide metrics. This includes the efficiency ratio, where a lower number is better, along with return on tangible common equity (ROTCE), tangible book value per share and the common equity tier 1 (CET1) ratio. ROTCE is an important metric in valuing financial institutions, such as determining what multiple to put on tangible book value, which is $42.30 per share. Morgan Stanley’s second-quarter ROTCE of 17.5% topped expectations of 15.7%, according to estimates compiled by Bloomberg. The CET1 ratio, meanwhile, indicates a financial institution’s ability to return cash to shareholders via buybacks and dividend payments. For that reason, we’re very happy to see a sequential increase here from 15.1% to 15.2%. Additionally, total client assets increased to $7.2 trillion, representing further progress toward management’s goal to reach $10 trillion over the long term. The star of the show was Morgan Stanley’s Institutional Securities segment, which houses all of the firm’s traditional Wall Street operations. Segment revenue of $6.98 billion easily topped analyst expectations, and all three main subsegments — investment banking, equity trading and fixed-income trading — surpassed consensus, too. On the call, CFO Sharon Yeshaya said the division benefited from the “strength of the integrated investment bank across U.S. and international markets. Higher activity in Asia contributed to results.” Unfortunately, results came up short in both the Wealth Management and Investment Management segments. Investors pay close attention to Wealth Management, in particular, because it provides a more durable, fee-based revenue stream and building that business has been a key focus in recent years. The weakness in Wealth Management is why Morgan Stanley shares initially fell on the release Tuesday morning. We then saw shares rebound only to take another hit as management commented on the call that “third quarter [net interest income] will be primarily driven by the path of sweeps, and NII could decline modestly in the third quarter.” Sweeps occur when a checking account exceeds a predetermined limit and the excess is “swept” into higher-yielding accounts, like a money market fund. So, why is the stock up nearly 1% in the face of a miss in Wealth Management and commentary that NII in the division may be down again in the current quarter? We think investors — including us — are viewing this as the trough in NII. Indeed, on the call, management said, speaking on the dynamics in Wealth Management, it believes “NII should inflect higher as you look out into next year.” Now layer in the continued rebound in investment banking, and what we get is an investor base willing to give management a bit more benefit of the doubt than they have in the past when it comes to Wealth Management weakness. There’s an expectation that results in the segment will pick up as we exit the year, providing for a very strong setup into 2025, which is in focus now that we are in the back half of 2024. The final wrinkle to understanding why the stock is up Tuesday: The current odds that Wall Street is placing on former President Donald Trump winning the election in November, which investors generally view as a positive for financial deregulation. These election bets may be driving some of the divergence between the Dow Jones Industrial Average and the Nasdaq on Tuesday. They also help us understand why Morgan Stanley shares were able to reverse higher and reach a new all-time high as the earnings call got underway, though the stock is off its highs of the session in afternoon trading. Patience with Morgan Stanley is warranted, even though we’ll continue to monitor the dynamics in Wealth Management. Results in that segment are likely to improve past the current quarter, and the investment banking recovery still has plenty of room to run, with management noting that the backlog continues to grow. Plus, even at current stock levels, we collect a roughly 3.4% dividend yield while the potential is higher that we see deregulation in the coming years. As a result, we are increasing our price target to $120 from $98 as we look to 2025. Still, we’re maintaining our 2 rating, meaning we’d wait for a pullback to buy more shares. Segment commentary Looking at the Segment Sales part of the earnings table below, Institutional Securities revenue handily exceeded estimates, fueled by better-than-expected results in all subsegments. Investment banking revenue surged 51% year-over-year with advisory fees increasing over 30%, equity underwriting fees jumping over 56%, and fixed-income fees surging nearly 71% from the year-ago period. On the call, finance chief Yeshaya said the firm’s investments in that segment “are beginning to have an impact as capital markets improve and activity picks up. … The pre-announced M & A backlog continues to build and suggests diversification across sectors.” Equity trading revenue rose 18% from last year due to broad-based strength in both key business lines and across various geographic regions. Fixed-income trading revenue jumped 16% year over year “driven by higher results in credit reflecting strong financing revenues and in foreign exchange on higher client engagement,” the firm explained in its earnings release. Total expenses for the segment (not seen on the table) increased 6.6% to $4.88 billion, on the back of a 3.4% increase in compensation expenses and a 9.6% increase in non-compensation expenses. The pre-tax margin was 29%, up from 17% in the year-ago period. Morgan Stanley’s Wealth Management segment revenue disappointed due to weakness across the board. Asset management revenue increased over 15% from the year-ago period, hitting a new record thanks to higher asset levels and the impact of positive fee-based asset flows. However, the firm gathered $36 billion worth of net new assets in the quarter, less than the $57.5 billion that Wall Street analysts anticipated, to bring its year-to-date total to $131 billion. Fee-based flows were $26 billion, marking the seventh consecutive quarter in excess of $20 billion. “We are seeing a steady migration of assets from advisor-led brokerage accounts to fee-based accounts, evidence that investments in our client acquisition funnel are paying off,” Yeshaya said. Fee-based assets stand at over $2 trillion. Transactional revenue fell 10% on a reported basis, but it was up 5% when excluding the impact of mark-to-market on investments associated with certain employee deferred cash-based compensation programs. The growth was tied to an increase in equity-related transactions. Net interest income came up short, as mentioned earlier, falling over 16% from the year-ago period. Driving the decline was a reduction in average sweep deposits as clients reallocated some of their cash in search of higher interest rates. Total expenses for the segment increased less than 1% annually to $4.95 billion. Pre-tax margin at the segment was 26.8%, a bit below the 27% the Street was looking for. Notably, Morgan Stanley’s deferred cash-based compensation program was a roughly 100 basis point headwind to the pre-tax margin. The Investment Management segment, by far the smallest of the three, outpaced expectations on the top line, even as total assets under management came up a bit short versus expectations. Asset management and related fees were up nearly 6% from the year-ago period on higher average assets under management, which benefited from increased asset values. Performance-based income and other revenue more than tripled, but it still remains largely immaterial given its size in the context of the firm overall. Total expenses for the segment increased by 4.7% annually to $1.16 billion, with both compensation and non-compensation expenses increasing mid-single-digit percentage points. Capital returns Morgan Stanley repurchased 8 million shares in the second quarter, at an average purchase price of $95.96 per share. The result is a return of capital to shareholders of $750 million, down from $1 billion in the first quarter. Given the firm’s 15.2% CET1 ratio, Morgan Stanley has plenty of excess capital at its disposal to both continue investing in growth and return some to shareholders. (Jim Cramer’s Charitable Trust is long MS. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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In this photo illustration, the logo for E-Trade, the online trading platform owned by Morgan Stanley, is shown on the company’s website on May 13, 2024 in Chicago, Illinois.
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Morgan Stanley on Tuesday reported second-quarter results that largely exceeded Wall Street expectations — though weakness in one key segment warrants closer monitoring even as the stock shook off earlier declines.
