Morgan Stanley: volatile but undervalued
With global markets expected to remain challenging over the next few quarters, the bank’s trading yield will also likely see a decline.
The global investment bank has been one of the most volatile financial stocks in recent months, along with Bank of America (BAC), and both have seen several single-day fluctuations of more than 5% as events related to the European debt situation unfolded. This extreme volatility can be largely attributed to the bank's extensive sales and trading operations, which can contribute anywhere between 30% and 50% of its total revenue from quarter to quarter.
The bank also has sizable exposure to Europe, much of it through the sales and trading platform. While we understand the risks these factors pose, we do not believe that the current market reflects the bank's intrinsic value.
We recently revisited our forecasts for the bank and revised our price estimate from $29 to $21, and detail below the reasons for these revisions.
Sales and trading operations remain weak
Morgan Stanley's debt and equity trading operations contribute to more than half its total value -- with each unit contributing almost equally.
Volatile market conditions resulted in poor sales and trading results for nearly all investment banks in the third quarter. Although banks have been cutting exposure to the riskiest economies in Europe, there is still a danger of the debt issues spreading to the larger French economy. Accordingly we expect most banks to be more cautious with their trading operations in the near future.
We have revised our previous forecast for Morgan Stanley's trading assets, as we expect near-term asset growth to be slower than previously estimated. Moreover, with global markets expected to remain challenging over the next few quarters, yields for the bank's fixed income, currencies and commodities, or FICC, trading business will also likely see a decline –- which we have incorporated in our analysis.
Advisory services activity to slow
Morgan Stanley's advisory services operations are also expected to slow down in the near term as economic conditions threaten to reduce global capital-raising activities. This will drive down the volume of debt origination, equity origination, and M&A deals.
We have shaved off nearly 25% from our earlier estimates for the size of global M&A deal volumes over our forecast period and still believe that fundamentals justify a higher valuation for the stock.
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