Morgan Stanley - Investors Applaud The Bank's Strategic Direction, Despite A Pick Up In Trading Activity

| About: Morgan Stanley (MS)

Shares of Morgan Stanley (MS) ended the week with modest gains of 1.3%. The global financial services firm reported its third quarter results on Thursday before the market open.

Third Quarter Results

Morgan Stanley reported third quarter revenues of $5.3 billion, down 46% on the year before. Excluding debt valuation adjustments of $2.3 billion, revenues came in at $7.55 billion, up 18% on the year before. Revenues came in ahead of analysts expectations of $6.4 billion.

The company reported a loss from continuing operations of $1.0 billion, or a loss of $0.55 per share. Excluding the debt valuation adjustment, income from continuing operations was $561 million, or $0.28 per share. Earnings, excluding DVA, beat analysts consensus of $0.24 per share.

CEO and Chairman James P. Gorman commented on the results, "Our third quarter results show a balanced, strategically focused franchise that has attained stronger revenues and executed on key goals. The rebound in Fixed Income & Commodities sales and trading indicates that clients have re-engaged after the uncertainty of the rating review in the previous quarter. We are beginning to unlock the full potential of the Global Wealth Management franchise, having increased our ownership of, and agreed on a purchase price for the rest of, Morgan Stanley Wealth Management. I am confident in our potential to enhance profitability and increase value for our shareholders in the quarters ahead."

Segmental Information

Institutional Securities

Revenues excluding DVA, rose 21% to $3.64 billion. Reported revenues fell almost 79% from $6.4 billion to $1.4 billion as the division had a negative $2.3 billion DVA adjustment, compared to a positive adjustment of $3.4 billion last year. Fixed income and commodity sales increased from $1.1 billion to $1.5 billion as a result of higher gains in interest rate products and gains on credit products. Equity sales and trading revenues fell from $1.3 billion to $1.2 billion.

Global Wealth Management Group

The global wealth management group reported third quarter revenues of $3.34 billion, up 3% on the year. Pre-tax income fell 33% to $239 million, as a result of $193 million of non-recurring costs associated with the purchase of a 14% stake in Morgan Stanley Smith Barney from Citigroup (C). Fee revenues rose 3% to $1.8 billion as a result of asset appreciation and fund inflows. Transactional revenues were unchanged at $1.0 billion on lower levels of client activity, while total client assets rose to $1.8 trillion at the end of the quarter.

Asset Management

The asset management division reported an operating profit of $198 million, compared to a loss of $118 million in the third quarter last year. Revenues tripled from $205 million last year to $631 million as a result of gains on principal investments in Merchant Banking and Real Estate. Assets under management rose from $268 billion to $331 billion as a result of inflows in liquidity funds and the appreciation of the market.


Morgan Stanley ended its third quarter with $43.4 billion in Tier 1 Common Capital. The Tier 1 capital ratio under Basel I came in at 16.7%, with the Tier 1 common ratio coming in at 13.7%.

For the first nine months of 2012, Morgan Stanley reported revenues of $19.2 billion, including DVA. The company reported an operating loss of $337 million. Full year revenues, assuming a zero DVA in the fourth quarter, could come in around $26 billion. The company is expected to roughly break even for the year.

The market currently values Morgan Stanley at $34.6 billion. This values the bank at 1.3 times annual revenues. Shares trade at just 0.66 times their tangible book value of $26.65, at quarter's end.

Morgan Stanley currently pays a quarterly dividend of $0.05 per share, for an annual dividend yield of 1.1%.

Investment Thesis

Year to date, shares of Morgan Stanley have risen some 15%. Shares traded at $15 in January and rose some 50% to $22 in March of the year. Shares fell to $12 after the trading scandal at J.P. Morgan unfolded, the world was worried about a collapse of the Eurozone, and Morgan Stanley received a credit downgrade from rating agency Moody's. Shares steadily recovered to $17.50 at the moment.

Over the past five years, shares of Morgan Stanley have fallen some 70%. Shares which peaked at $70 in 2007, fell to lows of $10 at the end of 2008. Shares recovered to $30 in 2009 but steadily moved downwards from that point in time. Investors should not expect to see share prices of 2007 anytime soon, as the number of shares outstanding roughly doubled to 2.0 billion.

The company remains on track to reduce its risk-weighted assets by $100 billion compared to last year. The bank is moving away from risky, capital-intensive trading businesses into the more stable wealth management division. Ironically, the trading division had a very good quarter as client activity increased. The downgrade from Moody's in June did not have a lasting impact on the relationship with counterparties.

During the quarter, Morgan Stanley bought a 14% stake from Citigroup in its joint venture Morgan Stanley Smith Barney. Morgan Stanley seems to have done a good deal, after Citigroup had to take a $4.7 billion write down on its stake in the business. I applaud the bank's move, as the strategic direction makes long term sense. Yet I refrain from investing in the bank, despite the discount to its book value, as I see few triggers for long term capital gains in the financial sector.

Disclosure: I 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.