Saturday, August 17, 2013

Morgan Stanley's Buying Its Stock--Should You?

Morgan Stanley (NYSE:MS) delivered second-quarter earnings July 18 that beat analyst estimates. As part of its announcement it indicated that it would repurchase $500 million of its shares. Morgan Stanley's buying its stock--should you?

Q2 Highlights

Adjusted revenues increased 25.8% year-over-year to $8.3 billion. Earnings per share were 45 cents, two cents higher than analyst estimates. EPS grew 42% year-over-year to 41 cents per share. Acquired the remaining 35% of its Morgan Stanley Smith Barney joint venture with Citigroup (NYSE:C) it didn't already own. Its pretax profit margin increased 50% year-over-year to 21% from 14% in Q2 2012. Assets under management or supervision increased 11.6% to $347 billion.

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SEE: Very Weak Q2 Earnings Outside Finance

Wealth Management
In March CEO James Gorman told investors that Morgan Stanley was moving away from its investment banking roots towards the wealth management business. Owning 100% of Morgan Stanley Smith Barney (MSSB) gives it the largest retail network in the world providing a huge audience for IPOs. municipal bonds, secondary offerings and other institutional products. Gorman's moves are meant to create three streams of income that are more stable in nature. In addition to wealth management, there will still be investment banking, which is incorporated into its institutional securities segment as well as investment management. Together, it's hoped the bank can become more profitable.

As mentioned previously, wealth management's pretax profit margin was 18.5%, its fifth consecutive quarter with a margin increase and its best rate since 2008. It expects to hit 20% or higher by 2015, which would get it closer to rivals such as Bank of America (NYSE:BAC). With the purchase of the remaining 35% of MSSB, Morgan Stanley moves from the 15th largest U.S.-based depository institution to the 10th biggest, leapfrogging BB&T (NYSE:BBT) and four others. Although cost reductions are a big part of why it wants 100% of MSSB, it's also a factor of retaining a greater portion of the former joint-venture's earnings. In Q1, if it had owned 100%, it would have retained $121 in pre-tax income instead went to Citigroup. By the end of fiscal 2013 it's possible that wealth management's pre-tax profit will be very similar to its institutional securities business on less revenue.

SEE: Bank Of America Brings The Growth

Buyback
UBS (NYSE:UBS) banking analyst Brennan Hawken characterized the Federal Reserve's approval of its $500 million share repurchase plan as "an indication that the Fed believes the firm is well capitalized…They're not in the penalty box any more." At current prices that's slightly less than 1% of its 2 billion shares outstanding. This is one instance where the amount is immaterial. I'm sure the amount repurchased in future years will rise as it continues to improve its return on equity and profitability in general. Investors might not be happy with the speed of change at the bank in the past but now that it's happening, the future is brighter than it's been in a very long time.

Fixed Income
Its fixed income, currencies and commodities (FICC) trading business, considered its weakest segment, increased 56% year-over-year to $1.2 billion. Although it was below its goal of at least $1.5 billion in quarterly revenue, it was a vast improvement from the second quarter in 2012. Its Q2 performance in terms of growth was better than all its rivals. Still, it's revenues are very volatile and the third quarter could be a downer. Analysts speculate that FICC would be the best business to sell at this point--especially if it's serious about generating stable and sustainable earnings. With big job cuts on the horizon I'd be surprised if it didn't entertain the idea of a sale before the end of 2013.

Bottom Line
Although it's up 45% year-to-date through July 18, it's still 41% below its five-year high. While it hasn't turned itself completely around, I think there are enough positives to get in while the good news is still fresh in the mind of investors. It might be moving away from its past to a certain extent, but wealth management is the right business to focus on given future demographics.

Do I think you should be buying?

I do. Just remember that this turnaround has been ongoing since 2010. Its stock is not going to double overnight. However, if it delivers two or three more quarters with generally positive news, I think it will really start to shine in 2014. If you're a patient investor, this bet should work out for you.

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