Best Idea for 2015: MS
As part of our December Ultimate Trial promotion, we are reissuing our reasons to own Morgan Stanley in 2015.
Morgan Stanley (MS) is a global investment bank offering institutional securities, wealth management, and asset management services, with 55,000 employees. Roughly 50% of its earnings are in the U.S. and 50% outside the U.S.
We've written in several recent notes that we continue to like the U.S. market with the improving fundamentals, while looking overseas for the true value propositions. MS has exposure to both, getting most of the credit for its domestic operations, and little for its international exposure. Over the course of the next few years, we could see more of an appreciation of Morgan Stanley's U.S. business, as the company continues to restructure it and reap the rewards. Ultimately, the international operations will be valued.
In the near term, and more important, the company has transitioned itself from primarily an institutional bank to one with more recurring revenues in global wealth management. We like the combination, and we see value in both segments. In addition to focusing more on global wealth management, the company has reduced its principal trading activity. Proprietary trading has been halted, and the company has reduced its commodities and currencies business.
At the same time, the regulatory requirements on capital and liquidity has led to a doubling of Morgan Stanley's equity base, while halving its leverage since 2007. This puts the company's balance sheet on firmer footing. Since 2007, returns have been squeezed and have fallen to 9% in the most recent quarter, from the upper 20% level. While we don't see a return to the good old days, we do see low teens in the next few years, as the company drives its market share higher in asset management and wealth management.
As the returns improve, so will earnings power, and we see Morgan Stanley earning $3 in EPS over the next two years. This is the goal of CEO James Gorman, and we like the fact that he is accountable to getting it done. He has strong credibility in executing his plan, since taking over the role in 2010. Given his prior experience in global wealth management, we see this segment as gaining more prominence, stronger market share, and continued inflows of assets.
For each of its businesses, we see different value drivers. In institutional securities, the emphasis is Basel III risk weighted assets. By reducing its exposure in the more volatile fixed income segment, the returns on capital should be higher over time, even in a static growth environment.
In wealth management, operating margins are the driver, and they are currently running at 13%. Management has goals of getting margins to 22%-plus by 2015, and to maintain this level going forward.
Clearly, the company needs higher net interest income to really see stronger results in this segment. This is where the better U.S. economy should help, as rates slowly improve from the very low levels today. It's not very hard to see the opportunity. As rates normalize, we estimate the company could see an addition $2 billion to $3 billion in net interest income, and for margins to approach the 25% level down the road.
In the investment management segment, the company is focused on size and scale. While this isn't the goal of the company, we do expect to see more of its expertise in certain segments of the market vs. broad-based coverage. As the company focuses its efforts in this way, profitability is key. Again, a stronger economy will lift all boats. We are encouraged with the current data points and the strong direction of growth. On valuation, the stock trades at 12.5x or 1.2x price-to- tangible book value (PTBV). Over the next year, we expect Tier 1 common equity to expand to 10%, annual revenue growth to increase 4% to 5% (which could prove conservative if rates rise), assets under management growth of 5%, margin expansion to 12%, and gross leverage at 14.5x.
We believe as the company gets closer to its return on equity (ROE) and margin goals, continues to improve its capital and liquidity position, and builds its wealth management market share, we should see a 14x to 15x multiple, and a mid $40s share price.
Regards,
Jim Cramer, Stephanie Link, and TheStreet Research Team
DISCLOSURE: At the time of publication, Action Alerts PLUSwas long MS.