We're lowering our price target on Morgan Stanley as shares tumble on earnings results

Published Wed, Oct 18 20233:12 PM EDT

Morgan Stanley (MS) reported better-than-expected third-quarter results Wednesday, even as investor disappointment over its wealth management business and the prolonged slump in investment banking weighed heavily on shares — prompting us to lower our price target on the Club holding. While it's fair to see the stock trade down on the earnings report, the punishment looks too aggressive ahead of what should be a much better 2024 for the investment-banking industry. And that's why we bought shares into weakness Wednesday. Revenue for the three months ended Sept. 30 increased 2% year-over-year, to $13.27 billion, outpacing analysts' expectations of $13.23 billion, according to estimates compiled by LSEG. Earnings-per-share (EPS) fell 6% on an annual basis, to $1.38, exceeding the $1.28-per-share estimate forecasted by analysts, LSEG data showed. Bottom line Morgan Stanley shares plummeted by 6.6% Wednesday, to hit a new 52-week low of roughly $75 apiece. The headline figures came in better than Wall Street expected, but the bank reported weak results at its investment-banking and wealth-management units. A softer performance in investment banking was not a surprise, given the current dearth of mergers and acquisitions and a still-frozen market for initial public offerings. But investors were clearly taken aback by shortcomings in wealth management, which had become the bank's most reliable segment. Wealth management revenues increased about 5% on an annual basis, but fell short of analysts' forecasts. Net interest income also came up short, as clients allocated more of their dollars to higher-yielding cash alternatives. More broadly, Wall Street was concerned over the bank's poor showing for net new assets, which came in at just $36 billion in the third quarter. In the first half of 2023, Morgan Stanley grew its assets by roughly $200 billion, in line with its target of adding $1 trillion in net new assets every three years — a goal we think is still attainable. Morgan Stanley management has previously said it would be misguided to extrapolate one quarter's results on net new assets to the next. And the total figure for this year, at $236 billion, still puts the bank on track to reach its $1 trillion goal. That's why we added to our position, and expect to see an uptick in new assets in the coming quarters. At the same time, investment-banking activity should pick up after the Federal Reserve signals it's finished raising interest rates. "The minute you see the Fed indicate they've stopped raising rates, the M & A and underwriting calendar will explode because there is enormous pent-up activity," CEO James Gorman said Wednesday. While we continue to be compensated by a large, safe dividend yield of 4.6%, we are, nonetheless, lowering our price target on Morgan Stanley to $95 a share, down from $105, to account for the sluggishness in investment banking and multiple compression across bank stocks. Institutional securities Investment banking revenues fell 27% from last year, as lower advisory revenues and fixed-income underwriting revenues were partially offset by higher equity underwriting. Advisory levels declined due to fewer completed M & A transactions, while fixed-income underwriting revenues were lower primarily due to lower event-driven, non-investment grade activity. Equity-underwriting revenues grew despite lower revenues from IPOs, mainly due to higher block offerings. Equity trading revenues increased 2% from last year, while fixed-income revenues declined 11%. Both topped analysts' estimates. Total expenses for the segment increased by 5%, to $4.38 billion, with growth in both compensation and non-compensation expenses. Wealth management Asset management revenue increased 7% from last year, reflecting higher average asset levels and the impact of positive fee-based asset flows. Transactional revenue also grew by 7% when excluding the impact of mark-to-market gains on investments associated with employee deferred compensation plans. Net interest income revenue fell by nearly 3% from last year, disappointing investors looking for largely flat results. The bank attributed the declines to clients moving money out of interest-rate-sensitive cash to higher-yielding cash alternatives. The decline is part of an industry-wide dynamic whereby clients are shifting funds to seek a better return in areas outside traditional cash accounts. Total expenses for the segment increased 4% annually, to $4.65 billion. Pre-tax margins at the segment were 26.7%, compared with 26.9% during the same period last year, or 28.4% excluding the impact of integration-related expenses. Investment management Asset management and related fees grew 3% from last year on higher average assets under management, which grew due to increased asset values. Total expenses for the segment increased by about 4% annually, to $1.1 billion, primarily due to higher compensation associated with carried interest. Capital returns Morgan Stanley repurchased 17 million shares in the third quarter, at an average purchase price of $87.59 per share, resulting in a return of capital to shareholders of $1.5 billion. That's up from $1 billion worth of stock repurchased in the second quarter, reflecting confidence in the bank's capital position. (Jim Cramer's Charitable Trust is long MS. See here for a full list of the stocks.) 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The Morgan Stanley headquarters is seen in New York City on Jan. 17, 2023.

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