Drivers of 4Q Performance for Morgan Stanley
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I believe franchise restoration, healthier market conditions and a lack of negatives from here should drive share price outperformance for Morgan Stanley (NYSE: MS), which is why I am bullish on the stock. While the environment in which MS is operating remains tough, I expect to see positive risk/reward in the event that capital markets conditions improve. The bank’s still weak return profile is already reflected in current valuations. The bank is expected to disclose is fourth quarter performance on the Jan. 14.
Drivers of 4Q Performance
According to Credit Suisse, during the last quarter of the prior year, industry-wide investment banking activity picked up. Debt underwriting remained resilient and equity underwriting witnessed solid year-end deal closings. Debt underwriting is expected to remain robust as near-zero interest rate and the accommodative financing environment continues to support new issue volumes.
Investment banking activity specific to Morgan Stanley remained promising. The bank is expected to close out the year on better than expected advisory and debt underwriting revenues. Credit Suisse expects $1.1 billion of investment banking revenues for MS, up 28% from a year-ago, 17% sequentially.
Conditions were fair for the sales and trading of both equities and fixed income as asset price stabilized and risk appetite for clients improved. The Credit Suisse global risk appetite index averaged 1.04 during the fourth quarter, up from -1.23 in 3Q2012, reflecting improvement in the client risk appetite. Conditions for fixed income ended on a quieter note in 2012. In contrast, equity markets conditions remained fair and at the same levels as they were during 3Q2012.
Given Morgan Stanley’s lagged pricing dynamics and the third quarter’s equity market appreciation, I anticipate sequential improvement in Wealth Management revenues. This should be somewhat offset by a decline in commission/transactional activity as retail investors become cautious in light of the US elections and fiscal cliff debate.
Analysts have a mean earnings per share estimate of $0.29 for the fourth quarter of the prior year on revenues of $7.11 billion. The earnings per share estimate is approximately 33% below the bottom line of the fourth quarter of the previous year.
Morgan Stanley has adequate capital as represented by its Basel I tier 1 capital ratio. At the end of the third quarter of the prior year, MS reported a tier 1 capital ratio of 16.9%. Comparatively, the tier 1 capital ratios for Goldman Sachs (NYSE: GS) and JPMorgan (NYSE: JPM) were 18% and 11.9% at the end of the third quarter of the prior year.
Morgan Stanley has attractive relative valuations compared to most of its peers in the US large cap banking industry. The bank trades at a 22% discount to its third quarter tangible book value, compared to an 8% discount for Goldman Sachs and 22% premium for JPMorgan.
Lack of headwinds and improvement in the market conditions during the fourth quarter of 2012 will help improve the performance of MS when it discloses its fourth quarter results on Jan. 14.
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