(MS) Morgan Stanley Analyst Maintains Underperform on Shares

We are reiterating our long-term Underperform recommendation on Morgan Stanley (MS). Though the company’s third-quarter results were significantly ahead of the Zacks Consensus Estimate, there are concerns regarding its financials being marred by various new regulatory requirements, elevated operating expenses and intense pricing competition.

However, the company’s restructuring initiatives along with its organic and inorganic growth strategies continue to be significant growth drivers.

Elevated operating expenses remain a major cause of concern for Morgan Stanley. In December 2011, in order to bring down costs and stabilize revenue growth, the company announced its plan to trim down its workforce in the first quarter of 2012. However, we do not expect this initiative to fully control the cost as the company continues to invest in its franchise.

As Standard & Poor’s (S&P) have downgraded the long-term credit ratings of Morgan Stanley in November 2011, the already high funding costs of the company are expected to increase further. This would also affect the company’s financials in the near term.

Additionally, a weak capital position is anticipated to prevent Morgan Stanley from enhancing shareholders value through dividend hikes and share repurchase activity. This time, the company, along with five other large banks – JPMorgan Chase & Co. (JPM), Citigroup Inc. (C), Bank of America Corporation (BAC), The Goldman Sachs Group Inc. (GS) and Wells Fargo & Company (WFC) – will have a higher stumbling block to clear in the stress test conducted by the Federal Reserve as they have significant exposure to the stressed European countries.

Morgan Stanley’s exposure to the real estate sector is also a cause of concern in the medium term. The company continues to incur significant losses in this sector as the growth is market driven. Various factors effect growth in the real estate sector leading to the contraction of the company’s bottom line.

However, things are not as bad as they seem to be. On the positive side, we anticipate Morgan Stanley’s decision to de-risk the balance sheet by resolving its 2-year-old legal dispute with MBIA Inc. will allow it to comply with various new regulatory requirements. This would also free up the additional capital that can be invested in its core businesses.

Furthermore, aided by strategic progress on restructuring, Morgan Stanley continues to remain profitable over the last several quarters, except the second quarter of 2011. We believe that strong trading activities and relatively stable credit spreads will enable the company to report decent results in the near term. Moreover, through various restructuring initiatives the company has been also trying to offset balance sheet risk.

Though investment banks across the globe are facing various headwinds, Morgan Stanley continues to enjoy competitive advantage from the growth in its core Institutional Securities’ franchise.

Currently, Morgan Stanley retains its Zacks #3 Rank, which translates into a short-term Hold rating.

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