Report
Michael Wong
EUR 850.00 For Business Accounts Only

Morningstar | Morgan Stanley's Conservatism Should Lead To Less Disappointment

Narrow-moat Morgan Stanley's relative conservatism going into 2019 has proven to be the right call. The company reported net income to common shareholders of $2 billion, or $1.23 per diluted share, on $10.2 billion of net revenue for the second quarter. Net revenue for the second quarter was 3% lower than a year ago and net revenue for the first half of 2019 is 5% lower than the first half of 2018, but the company's return on equity remained solid at 12.1% year-to-date. Overall, since the back half of 2018, the economic environment has become more unsettled due to slowing global growth forecasts, discussions around U.S. trade policy, and changes in interest rate expectations. While first half of 2019 revenue is about 10% above the second half of 2018, continued growth or even stability of revenue and earnings for the next year is anything but certain. We don't expect to make a significant change to our $52 fair value estimate for Morgan Stanley.

The company's more conservative management of expenses and guidance has less possibility to disappoint. Non-compensation expenses averaged $2.7 billion in the first half of 2019 compared with $2.8 billion in 2018. With revenue having heightened unpredictability, a tight lid on costs seems like a reasonable approach. Management has also steadfastly refused to increase operating margin targets in its wealth management business from a range of 26% to 28%. Wealth management margins actually came in at a high since the integration of Smith Barney at 28.2%, likely partly due to the Smith Barney retention notes rolled off. However, with the potential for a correction in equity markets and net interest income headwinds from lower long-term interest rates with the 10-year Treasury close to 2% compared with around 3.25% in late 2018, and expectations for federal-funds rate cuts, the 26% to 28% band gives the company some buffer.

Beyond macro factors that can affect the profitability of Morgan Stanley's wealth management business, there are some more micro factors that are showing signs of a slowdown or deterioration. After having 3 sequential quarters of increasing financial advisor headcount, headcount decreased by 75 to 15,633, which puts it just 1 ahead of the 15,632 a year ago. The company had been purposely decreasing headcount since the Smith Barney integration, but the net recruitment over the previous quarters could have provided another avenue for asset growth that's independent of market movements. That said, advisor productivity remains high at over $1.1 million of revenue per advisor and over $160 million of client assets per advisor.

Another area that has shown some deterioration is deposits. U.S. bank deposits have decreased to $176 billion from a peak of $187 billion in the fourth quarter of 2018. Additionally, bank deposits as a percentage of wealth management client assets has declined to 6.87%, which is the lowest since the first quarter of 2018. While net interest income may not be as important to Morgan Stanley as the large money center banks in the United States, the growth of the company's bank assets and deposit base have been major drivers of the expansion in the wealth management segment's operating margins that arguably underpinned the company's outperformance in recent years.

In the second quarter, Morgan Stanley received a nonobjection for its 2019 capital plan from the Federal Reserve. The company's capital plan calls for common stock repurchases of up to $6 billion and an increase in the quarterly dividend per share to $0.35 from $0.30. The total capital plan is approximately equal to the company's $8.2 billion of net income to common shareholders reported in 2018. Shares of Morgan Stanley are currently trading at a slight discount to our fair value estimate, so repurchases near current prices should be modestly accretive.

Real GDP growth in the United States in the first quarter was 3.2% annualized, an improvement from the 2.2% rate of fourth-quarter 2018. Recent economic data indicates lower growth in the second quarter, with the Federal Reserve Bank of Atlanta forecast model estimating GDP growth of 1.4%. The consumer price index increased at an annual rate of 0.7% in June, declining from the near-1% rate in May. And, the core level of inflation, which excludes food and energy, posted a 3.5% annualized rate in June, breaking a streak of four consecutive months below the Fed’s 2% target.

The ISM purchasing managers' manufacturing index, generally the first data release following month-end, fell to 51.7 in June, its lowest level since October 2016. Similarly, the ISM non-manufacturing index, at 55.1 for June, also fell to a multi-year low. An index level over 50 represents continued expansion, and the ISM metrics indicate a potential slowdown, rather than imminent recession. The IMF projects GDP growth of 2.3% for the U.S. economy in 2019, with forecast growth declining to 1.9% in 2020. The IMF is also forecasting 2% inflation for the year, with prices expected to rise at a 2.7% clip in 2020.

The Federal Reserve maintained the target range for interest rates at 2.25%-2.50% following its June meeting, holding benchmark rates stable since the last increase in December. In contrast to previous meetings, the vote to maintain rates was not unanimous, with one member voting to lower rates. The Fed has made clear it will "act as appropriate to sustain the (economic) expansion" and Chairman Jerome Powell has indicated that rate cuts are on the table with intensifying economic and geopolitical risks. Any near-term rate cuts would likely be more to prevent a significant slowdown in the U.S. economy than an indication that we’ve entered into a recession. The futures market is anticipating a rate cut at the next Fed meeting in late July, and it appears a dovish shift in Fed monetary policy is on the horizon.
Underlying
Morgan Stanley

Morgan Stanley is a financial holding company. Through its subsidiaries and affiliates, the company advises, and originates, trades, manages and distributes capital for, governments, institutions and individuals. The company's segments are: Institutional Securities, which provides investment banking, sales and trading, lending and other services; Wealth Management, which provides brokerage and investment advisory services, financial and wealth planning services, stock plan administration services, annuity and insurance products, residential real estate loans and other lending products, banking, and retirement plan services; and Investment Management, which provides investment strategies and products.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Michael Wong

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