Morgan Stanley Not In Position To Grow Dividend
Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After the 2008 market crash, many companies in the financial sector were hit hard. When a business as a whole is severely hurt, resulting in major losses, the first to be affected are common shareholders in the form of dividend cuts. Morgan Stanley (NYSE: MS) was among the companies who were damaged from the systemically driven disaster. However, with improving cash flows and margins and with a revamping overall economy, some companies are beginning to find the extra cash to compensate investors. I will explore the possibility that Morgan Stanley is one of those companies and conclude with a projection.
Dividend History
From 2001 through 2003, Morgan Stanley paid an annual dividend of $.92. It increased this to $1.00 in 2004 and from 2005 through 2008 it paid $1.08. After the market crash in 2008, it reduced its annualized dividend to $0.42 in 2009 and to $0.20 in 2010. This 1% dividend yield is where it remains today. With a 16% payout ratio, Morgan Stanley pays $0.05 per share quarterly. This leaves two possible ways for Morgan Stanley to increase its dividend. It can either reduce its retention ratio or it can escalate earnings in such a way that 16% accounts for more than just $0.20 per share.
Competitive Position
Morgan Stanley is in the investment brokerage industry and has an operating margin of 18.85%, compared to the industry’s 10.51%. Goldman Sachs (NYSE: GS), a main competitor, yields a 1.2% dividend but does so having to pay a higher percent of earnings, with a 31% payout ratio. However, if Goldman can sustain these dividends, it might be seen as a better investment. This is an incentive for Morgan Stanley to increase its dividend.
Exposure to European sovereign debt is still a concern. However, fourth-quarter 2011 losses were not as extreme as some expected. Management has been taking necessary steps towards detaching it from European sovereign debt as well as to endure any dissatisfactory regulatory reforms. However results from these restructuring efforts won’t be immediately recognized.
Profitability
From 2009 to 2010, revenue grew by 35.3% and from 2010 until the trailing-twelve-months (ttm), revenue grew by 9.5%. From 2009 to 2010, net income grew by 250%. From 2010 until now, net income grew by 10.5%. Furthermore, the profit margin, excluding net income applicable to common stock, was 5.8%, 14.9% and 15% in 2009, 2010 and the trailing-twelve-months, respectively. However, after the required payment to preferred shareholders, we see a different story. Net profit margin, when considering net income applicable to common shares, is -3.88%, 11.37%, and 8.55% in 2009, 2010 and during the trailing-twelve-months, respectively. So, when considering the obligation to preferred shareholders, the net margin has been jumpy for the last few years. However, disregarding this obligation while solely considering efficiency, Morgan Stanley has been annually increasing profitability. If net income continues to increase, the preferred payment will become less of a burden and Morgan Stanley will further increase its ability to compensate common shareholders.
Cash Flow & Liquidity
From 2001 to 2007, Morgan Stanley had an average free cash flow to net income of 0.7. During the same period, it sustained an average dividend of $1.00 per share. After recognizing sizeable negative free cash flows in 2008 and 2010, the current trailing-twelve-months free cash flow to net income is 0.05. Although free cash flow is not entirely related to dividend payment, this scrunching of liquidity suggests that a current dividend increase will be unsupportable. More cash will be required to cover short-term obligations, such as capital expenditures as the ratio suggests.
Something that I found interesting is that from 2001 until 2007, operating cash flow was consistently a usage of cash, rarely positively contributing to the end cash result. This was generally due to a payment of liabilities. Recently, there has been a cash increase due to operating activities but in 2010 and most recently it was mainly due to an increase in liabilities. In fact, in 2010, the cash increase from a change in liabilities was almost half of the net cash provided by operating activities.
Projection
Morgan Stanley is not generating the same numbers as it had when it was paying the dollar and up dividend. With the current market and economic conditions, Morgan Stanley is not in a position to increase its dividend payment. This is not to say that it won’t. Management might be pressured into a slight increase towards the end of the year. If there is an increase in the dividend payment, it will likely move no higher than the 2009 level of $0.42 per share annually. It should take at least two years for Morgan Stanley to raise its dividend to the level it was before the crash.
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