Morgan Stanley: A Fluke?

| About: Morgan Stanley (MS)

Summary

I recently initiated coverage on Morgan Stanley where I refused to get behind the stock despite the fact its results may have been a fluke.

Q4 earnings are out now and I discuss the key metrics.

I discuss how I view traditional versus investment banking.

I recently initiated coverage on Morgan Stanley (NYSE:MS), which is one of the largest banking firms in the United States. At the time, I discussed that traditional banking was providing a win for the company. Those banks that are more heavily focused in this aspect were outperforming in most cases and that remains true. I talked about how the banks' Q3 was awful quarter, led by disaster in trading. After discussing key metrics I stated that:

"I cannot get behind the stock at this point. While the share price is attractive to me on a simple valuation basis, I have no faith in the fundamentals at this juncture. I am going to need another quarter or two to be convinced that this was a fluke."

To me, Morgan Stanley has always been an investment bank, and as such, I have avoided discussing it because I tend to focus more on traditional banking. But because I had said I needed another quarter or two to see whether this name was one I could recommend, I am following up as the company just reported its Q4 results.

While the major banks aren't exactly outperforming, they were for the most part doing better than this name in terms of stock performance in 2015. They were also doing better in terms of absolute performance. So what is the deal here? Is this name bank on track? Did I initiate coverage during a fluke?

Well the bank reported net revenues of $7.7 billion for the quarter. Ok. That's not terrible right? Well it was down from $7.8 billion a year ago. Excluding DVA revenue was $7.9 billion, which beat estimates by $310 million. That is strong. The year-over-year decline is not terribly surprising given currency issues and other factors plaguing the sector. Ok well what about the bottom line? Well, net income applicable to Morgan Stanley was $908, or $0.39 per share, compared with net losses of $1.6 billion, or $0.91 per share last year. Of course last year's quarter included some special significant items which account for a heavy portion of a net loss of $1.37 a share.

Seems the quarters are hit and miss on the surface. Let's dig a little deeper into this quarter. Trading activity is what really plagued the company. Its "Institutional Securities" segment reported revenues of $3.5 billion and were strong. Pre-tax income from continuing operations of was $548 million compared with a massive pre-tax loss of $3.67 billion in the fourth quarter of last year. Excluding DVA pre-tax income was $672 million, whereas last year's pre-tax loss was $3.9 billion. What is good to note is that this $672 million is up from the $253 million last quarter. On top of that advisory revenues were $516 million up from $488 million due to merger activity. However equity underwriting, which can be tough to predict, only saw revenues of $346 million, down from $462 million a year ago. Equity sales and trading net revenues of $1.8 billion were up from $1.6 billion last year, while fixed income and commodities sales dropped to $550 million from $559million a year ago. Overall, it was a much better quarter, but I really am uneasy with the movement in key metrics. That is, some items are up while others are down. I like consistency.

The "Investment Management" segment turned around year-over-year. It reported pre-tax income from continuing operations of $123 million compared with a pre-tax loss of $6 million last year. Revenues were down substantially. Net revenues were up as well coming in at $621 million versus $588 million last year. But why the increase? It was mostly due to the fact that results in the "Merchant Banking and Real Estate Investing" business were higher.

How about the "Wealth Management" side of things? Surely this should be slightly more predictable as this is where some of the traditional banking resides. Well, here the company continues to do well. This segment saw income from continuing operations of $768 million compared with $736 million last year. A modest improvement. However, revenues dropped $110 million to $3.64 billion compared with $3.75 billion a year ago. Revenue declined mainly due to lower cash being brought in from banking transactions. Last year these accounted for $976 million in revenues. Fast forward to this quarter and that was sliced to $861 million. Net interest income saw a bounce thanks to growing deposits and loans. You see, traditional banking with slow and steady growth is the way to go. It grew to $779 million from $625 million a year ago on higher deposit and loan balances. Total client assets were $2.0 trillion and client assets in fee based accounts were $795 billion at quarter end. Overall, I was pleased with performance here.

So what is the moral of the story here? Well once again, traditional banking is providing a win. Investment banking is very unpredictable. Two weeks into Q1 2016 here and I bet losses are heavy thanks to the markets. At least so far. Traditional banking may not be able to provide outsized returns, but those banks that are more heavily focused in this aspect are outperforming in most cases. This was a much better quarter led by a turn-around in trading versus the third quarter, but I have to say that I really am uneasy about the volatility in revenue and earnings metrics. For this reason I still cannot get behind the stock at this point, but I will say the entry point is attractive at current levels thanks to the recent selloff. At this point a buy is a speculation on increased trading activity and returns. I have concerns there. While the third quarter may have been a fluke, I just still am not comfortable with the fundamentals here.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.