Gorman Path to High Returns Gets Mixed Review as Stock Leaps
Morgan Stanley (MS) Chief Executive Officer James Gorman’s plan to boost returns has split analysts as they debate whether his strategy will satisfy investors. The market says it can.
The stock surged 11 percent in the two trading days since the New York-based bank reported fourth-quarter results and Gorman laid out his plan for higher returns. David Hilder, a Drexel Hamilton LLC analyst, cited the strategy in raising his share-price estimate, while others including Atlantic Equities LLP’s Richard Staite expressed doubt the firm could attain Gorman’s goals over the next few years.
Gorman called the fourth quarter a “pivot point” as he moves from managing the aftermath of the financial crisis to focusing on improving profit. With investors pressing for better results, Gorman laid out a plan to double return on equity to 10 percent even if markets don’t rise.
“Just the fact that we’re having a call where they’re talking about long-term strategy and profitability is refreshing,” said Shannon Stemm, an analyst at Edward Jones & Co. in St. Louis. “This is something that you hope you’re able to think and talk about every single quarter, but that has not been the case with Morgan Stanley because they’ve been very bogged down in some of these legacy issues.”
Whether Morgan Stanley can meet its cost of equity, estimated at about 10 percent, has become a matter of debate among investors as new capital requirements force the firm to fund itself with a lower proportion of debt. The bank has traded below book value for more than 2 1/2 years.
Gorman pledged to buy out the rest of the firm’s brokerage joint venture with Citigroup Inc. (C) this year, improve margins in that business and increase lending to wealth-management clients. He also laid out a plan to cut $1.6 billion in costs across the firm and reduce capital devoted to the fixed-income trading unit at a faster pace than previously planned.
Those efforts should improve return on equity to 9 percent, Gorman said during a Jan. 18 conference call. Returning capital to shareholders through share repurchases and dividends should boost the figure to 10 percent, equivalent to a 12 percent return on tangible equity, or ROTE.
The bank didn’t put a date on its return goals. Roger Freeman, a Barclays Plc analyst, wrote yesterday that he still expects return on equity to remain below 9 percent for the next two years. Sandler O’Neill & Partners LP’s Jeff Harte, in a note titled “The Long and Winding Road to a Double-Digit ROE,” said he couldn’t see a 10 percent return without “significant operating environment improvement.”
“If you’re not going to put a time horizon on it, 12 percent is not a heroic target,” said David Trone, a JMP Securities LLC analyst, referring to the ROTE target.
The bank said it plans to reach the $1.6 billion target for cost reductions during the next two years, with some savings coming from 1,700 job cuts this month. The fixed-income shrinkage is set to occur over the next four years.
Some analysts, including Staite, questioned whether the firm could cut jobs and fixed-income assets without sacrificing revenue. Chief Financial Officer Ruth Porat said the $40 billion of reduction in risk-weighted assets the firm made in the second half of 2012 had “minimal” revenue impact.
The stock posted its biggest two-day gain in seven months, rising 8 percent to a 17-month high, after Gorman disclosed his plan on Jan. 18. Keith Horowitz, a Citigroup analyst, said the strategy excited investors more than Morgan Stanley beating profit estimates as the cuts in assets and expenses exceeded expectations.
Doug Sipkin, a Susquehanna Financial Group analyst, lowered his rating on Morgan Stanley to neutral from positive in the wake of the shares’ rally. The shares fell 1.4 percent to $22.67 at 10:05 a.m. in New York trading.
“The ‘story’ aspect of MS is now appropriately discounted in the stock,” Sipkin wrote in a note to investors yesterday, referring to the company’s ticker symbol. “As a result, the burden of proof will now shift to earnings.”
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