Investors expected Morgan Stanley (NYSE:MS) to reward them with a handsome hike in capital returns this year, and the investment banking giant did not disappoint as it detailed plans to return as much as $5 billion in cash to shareholders over the next four quarters late last week. The proposed plan includes a 33% hike in dividends from the current 15 cents a share to 20 cents a share beginning Q3 2016. The bank will also initiate a new share repurchase program to buy back up to $3.5 billion of its shares over the next twelve months.
The bank, which is the best capitalized among all U.S. banking giants (email registration required), had no issues in clearing the quantitative phase of the Fed's 2016 stress tests. But it was not all smooth sailing for Morgan Stanley in the qualitative phase, as the Fed observed "material weaknesses in (the bank's) capital planning process" (see Lots Of Winners In The Fed's 2016 Stress Test, But Deutsche Bank, Santander Stumble Again). Although the Fed did not find this issue big enough to reject the proposed capital plan, Morgan Stanley has to fix the deficiencies pointed out and resubmit its capital plan by the end of the year.
We believe that the conditional approval is a minor hiccup, which should be easily resolved over coming months, and maintain our $38 price estimate for Morgan Stanley's stock, which is about 50% ahead of the current share price. The price discrepancy can primarily be attributed to the sharp sell-off in bank shares over recent months as fear of the U.K. leaving the European Union grew.
Historically, Morgan Stanley focused considerably on returning cash to investors - something that was a common trend among investment banks prior to the economic downturn. Like its peers, Morgan Stanley preferred to do so not by paying out a high dividend each quarter, but by buying back shares worth billions of dollars each year. This is evident from the fact that the bank's increase in quarterly dividends between Q1 2000 to Q1 2009 was not sizable, but by the end of this period, the bank was routinely spending three times the amount it handed out as dividends to repurchase shares.
The table below puts things in perspective, as it summarizes Morgan Stanley's capital return figures for each year since 2005. The data has been compiled using figures reported in annual reports:
The disparity in Morgan Stanley's payouts to common shareholders before and after the economic downturn stand out clearly here. But a poor operating performance over the period was not the only factor to blame for this. The bigger reason was that Morgan Stanley was saving up to acquire 100% of the Smith Barney brokerage business from Citigroup (NYSE:C). In fact, once the bank completed the acquisition in early 2013, its plan to buy back $500 million worth of shares was approved by the Federal Reserve within a couple of months.
But the real boost came in 2014, when Morgan Stanley doubled dividends to 10 cents a share and also put in place a program to repurchase shares worth $1 billion for a total payout of $1.8 billion. The bank went on to hike the proposed payout figure by almost 150% in 2015 to $4.25 billion, and is now looking to top that amount by returning $5 billion over Q3 2016-Q2 2017.
As Morgan Stanley paid $0.15 in dividends per share over the first two quarter of 2016, and proposes to pay $0.20 per share over the remaining two quarters, total dividends for the year should be $0.70 per share. This works out to total dividends of around $1.3 billion for the year, assuming the total number of shares outstanding remains constant at the current level of 1.9 billion.
Also, the bank repurchased $625 million in shares over Q1 2016 and had authorization in place to repurchase an additional $625 million for Q2 2016 - taking the total repurchase figure over the first half of the year to $1.25 billion. Taken together with $1.75 billion in proposed purchases for the rest of the year (half of the total proposed repurchases of $3.5 billion), this points to total share repurchases of $5 billion in 2016 - the highest in the history of the bank.
We represent dividend payouts and share repurchases in our analysis of Morgan Stanley in the form of an adjusted dividend payout rate, as shown in the chart below. Note that we represent this payout rate as 0% in the chart for 2008, 2009 and 2012 as the figure was not meaningful. You can understand how a change in Morgan Stanley's adjusted payout ratio affects its share value by making changes here.
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