Summary
- Morgan Stanley beat expectations in Q2, thanks to blow-out results from its trading and investment banking unit.
- However, the asset management divisions continue to churn out steady results, providing a base of consistent cash flows.
- While trading grabs the headlines, asset management drives most shareholder value and can propel shares higher.
Shares of Morgan Stanley (MS) rallied over 2% on Thursday as investors digested strong quarterly results. Among banks, the second quarter was a tale of two cities with commercial banking doing terribly amid a surge in reserves while trading generated outsized profits. Banks reliant on commercial operations, like Wells Fargo (WFC), reported poor numbers, those with a balanced mix like JPMorgan Chase (JPM) reported decent numbers, and those more focused on markets like Morgan Stanley and Goldman Sachs (GS) had blowout numbers. Even with shares within 7% of their all-time high and trading activity likely having peaked, I still see upside in Morgan Stanley.
To be clear, MS’s results in Q2 were really very strong (financial data available here) with EPS of $2.04 nearly doubling consensus thanks to a 31% jump in revenue to $13.4 billion. While revenue was up $3.2 billion from a year ago, compensation expense only rose $1.5 billion as Morgan Stanley was essentially able to pocket a disproportionate chunk of excess trading revenue.
And, there was a lot of extra trading revenue as Morgan Stanley’s traders and market makers were able to capitalize on the extreme volatility throughout the quarter to generate outsized profits. Sales & trading revenue was up 67% to $5.55 billion. Fixed income trading was up an unthinkable 177% to $3.033 billion. This one unit, which was 11% of MS’s revenue in Q2 2019, generated 60% of Morgan Stanley’s revenue growth. On top of extra trading revenue, the surge in debt and equity issuance as companies sought to shore up their liquidity given the economic uncertainty led to a windfall of investment banking revenue with fixed income underwriting up 68% to $707 million.
Truly, this was an extraordinary investment banking quarter, from both a trading and underwriting perspective. Consequently, the institutional securities business doubled pre-tax income to $3 billion. However, this extra $1.5 billion is really a one-time windfall, assuming markets do not maintain this level of volatility permanently, rather than an indicator of the unit’s recurring income capacity.
While investment banking results generated all the headlines, those income numbers will wildly fluctuate, and MS’s asset management is the steady cash flow generator. Once again, it reported strong numbers. Wealth management revenue was up 6% to $4.68 billion, though these revenue gains were offset by commensurate compensation costs. Investment management also saw a 6% increase in revenue but kept compensation costs broadly unchanged at $354 million. Consequently, the asset management units generated $1.36 billion in pre-tax income, similar with last year’s results.
