Tuesday, March 17, 2009

Morgan Stanley (NYSE:MS): Downgraded to Underperform at Merrill Lynch/BAM; $21 tgt

Merrill Lynch/BAM is downgrading Morgan Stanley (NYSE:MS) to Underperform from Buy while lowering their tgt to $21 from $25.

Firm notes they are downgrading MS to Underperform after a significant run over the past week which has brought shares in line with their price objective.

Neg. Marks from Real Estate, MS debt spread tightening expected to drag on 1Q results
In particular, they are concerned that Real Estate merchant banking losses and a negative mark related to MS credit spread tightening will be a drag on 1Q, suggesting a result well below consensus. MS has a broader exposure to Commercial Real Estate than most of its peers, since it has the largest RE Private Equity-type business in the industry, and it’s also a significant Commercial RE lender.

Lower EPS: 1QE to $0.21 fr $0.41; ‘09E to $1.70 fr $2.24
1Q cut reflects the expectation of $1.2bn in Real Estate/Private Equity marks and $300mn in marks to reflect MS debt spread tightening exacerbated by a slightly higher comp. ratio as firm continues to invest in a weak operating environment. The cut to ‘09E reflects the compensation pressure as well as additional negative marks on the expectation MS spreads will continue to tighten. Firm notes also that they expect MS to report a significant $0.50-1.00 loss for the December stub.

Cutting PO to $21 from $25 on lower ROE expectation
The shares at $23 are at 77% of BV and thus discount 7-8% ROE, while their new 09E for ROE is under 5% (1Q expectation is close to 1%). They are taking the PO down to $21, which still discounts 6-7% on the expectation that a year out the market will be looking for ROE at least that high. Still, it does indicate some downside, further explaining the Underperform rating.

Notablecalls: I think MS will get hit on this as it has absolutely ripped over the past weeks and will catch a lot of people by surprise.

Merrill's comments regarding a sizable miss in Q1 read badly. I expect the stock to go sub-$22 today.

Also note that Keefe is out with a downgrade on Goldman Sachs (NYSE:GS) this morning (to MP from OP) which will create some addnl selling pressure. Also, the WSJ article regarding the inv. banks looking for loopholes to pay their execs bonuses above the capped rate might create some nervousness.

Overall, I think all this will generate a pull-back for the general mkt today. Will be a healthy test.

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