Monday, January 04, 2010

Morgan Stanley (NYSE:MS): Upgraded at UBS & Credit Suisse

Morgan Stanley (NYSE:MS) is getting two tier-1 upgrades this morning:

- UBS is upgrading MS to Buy from Neutral with a $37 price tgt (unch) noting that while earnings, ROE, and book growth will likely still be sluggish in the near term, they think some meaningful company-specific headwinds are dissipating, the firm’s capital and liquidity positions remain strong, investment banking pipelines are building, management is in the process of re-building the FICC & prime brokerage footprints (should lead to market share gains), and the integration of the Morgan Stanley Smith Barney JV appears to be on track.

In addition, Morgan’s book value per share and Tier 1 common ratio (8.2% as of 3Q but ~10% including the CIC mandatory convertibles) will get a boost in 3Q10 when the $5.6 billion of CIC equity units convert to common stock (the units convert at ~$48 per share, so the conversion will be dilutive to EPS but accretive to book value per share).

Even if book value does not grow much over the next 12 months, the firm thinks Morgan Stanley’s stock can head higher as its price-to-book multiple should expand as the macro backdrop improves and the firm begins to post consistently profitable quarters. The stock currently trades at 1.1x book versus 1.5x for Goldman Sachs. While they continue to believe Goldman deserves a solid premium, they don’t think it is unreasonable to think that MS could trade at 1.2x forward book value over the next year, which is what UBS' $37 price target is based on (no, they don’t think investors will drift back to looking at tangible book). Longer-term, while the company might need the bulk of its next three years of earnings to buy in the rest of the Smith Barney JV, shareholders are expecting the more stable business mix will bring more consistent earnings, a better ROE and of course, an even higher multiple.

To be clear, UBS understands that full ownership of Morgan Stanley Smith Barney is a long ways off and there is some execution risk around the JV. In addition, Morgan remains a work in progress as a new CEO and CFO will take the reins in 1Q10 and the trading franchise has lost some market share over the past 12 months. Finally, there will be some share dilution related to the CIC mandatory convertibles (116 million shares) and potential MUFG preferred conversion (potentially ~311 million shares), but they have already factored this into our forward estimates. In one respect, UBS thinks some of these issues offer opportunities for future improvement as it is fair to say that most of Morgan Stanley’s businesses, with the exception of the investment banking franchise, have been underperforming over the past 12 months. If management can generate some improvements in trading (MS is in the process of adding talent) or asset management, then the firm will likely be able to show some attractive y/y improvement in 2010 which may be tough for competitors to do given their relatively strong showings in 2009.

- Credit Suisse is upgrading MS to Outperform from Neutral with a $38 price target (prev. $32) saying they are taking advantage of recent share price weakness. While the firm expects fourth quarter results will be lackluster (they’re reducing their estimate today), they believe 2010 will represent an inflection point for franchise profitability, operating margins and book value growth which they believe should drive valuation restoration and share price outperformance. CSFB sees stabilization and payoff from investment spending initiatives within the Institutional Securities franchise and the realization of Global Wealth Management integration helping to drive realization of $3.50+ earnings power. In addition, they believe 2010 drivers of book value growth (absent core earnings growth) are underappreciated, including the conversion of the CIC stake (August), sale of Van Kampen (mid-2010 closing) and continued workdown of outsized headwinds (debt spread valuation, real estate investments). Finally, capital levels remain strong (Basel I Tier 1 15.4%) and they see opportunities for more active capital management down the road.

Notablecalls: Nothing big here apart from maybe the fact two tier-1 firms decided to upgrade the stock on the same day. With the stock down almost 20% from recent highs we are likely to see some buy interest in the name today.

They can probably take MS to $30.50-30.75 level but I'm hesitant to call for any further upside from there.

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