Don't Pop the Champagne Yet for Morgan Stanley
Though the narrow-moat firm had a great quarter, this profitability level isn't sustainable.
Morgan Stanley (MS) practically fired on all cylinders in the first quarter of 2018, but a return to normal in its institutional securities segment and a potential slowing in the wealth management business can be signs for caution. The company reported record net income to common shareholders of $2.6 billion, or $1.45 per diluted share, on $11 billion of revenue. Return on equity was an exceptional 14.9% and return on tangible equity was 17.2%. We continue to believe that the company can generate strong returns through a business cycle, hence our narrow-moat rating for Morgan Stanley, but believe that this quarter’s returns were abnormally good. We don’t anticipate making a material change to our $50 fair value estimate for the firm, as this quarter’s results don’t change our over-a-cycle profitability forecast.
The institutional segment should normalize lower. Similar to other capital market-related firms that benefited in the first quarter from asset price volatility and increased investor engagement, institutional trading revenue was the standout performer, increasing 26% from the previous year and 64% sequentially to $4.4 billion. $4.4 billion is approximately 40% higher than the trailing three-year average, and the 35% operating margin in the institutional group compares with a three-year average of about 28%. It’s clear that this profitability level isn’t sustainable.
The wealth management segment was a bit mixed. Its pretax operating margin is breaking new ground at 26.5%, but client assets and net interest income slightly dipped sequentially. The small decrease in client assets may be mainly due to choppy asset prices in the quarter, but there could be some fundamental changes in net interest income. Net interest income may be affected by Morgan Stanley’s deposit base becoming strained and having to stretch for higher cost funding sources.
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Michael Wong does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.