UBS/Morgan Stanley: Credit Suisse should help Ermotti close the gap

Markets reward a listed business’s “journey” to higher profits, less so its arrival. The price of a fare on the UBS train has risen of late to around 1.3 times tangible book, the highest in five years. Yet that valuation would need to nearly double to catch up with US rival Morgan Stanley.

The forced purchase of struggling Swiss peer Credit Suisse may take UBS some way towards that goal. However, UBS will have to sort through the baggage of its target first.

Tuesday’s first-quarter results gave investors a peek at how UBS had been doing before the deal. They were presented by Sergio Ermotti, the formidable former boss who has already replaced seat-warming Dutchman Ralph Hamers.

There were few surprises. A common equity tier one ratio of 13.9 per cent was slightly lower than expected.

More importantly, Ermotti offered a snapshot of a combined business with some $5tn of invested assets. Getting there without the deal would have taken UBS another 7-10 years.

Should investors reward UBS for its unexpected great leap forward with a bigger valuation multiple, something closer to Morgan Stanley’s 2.1 times tangible book? Greater scale should help but the groups already have much in common. At the end of March, UBS’s underlying 15 per cent return on tangible equity trails that of Morgan Stanley by roughly two percentage points. Growth rates for net earnings per share look similar to 2025, though UBS will have integration costs to come that analysts have yet to model.

There are key differences, of course. Morgan Stanley is highly exposed to the dynamic US economy. Its core Japanese shareholder Mitsubishi UFJ owns 22.6 per cent. US index funds have large stakes too. One theory is that these holdings amplify the effect that good results have on the share price via a restricted free float.

UBS cannot replicate those attributes. But it should, in time, be able to narrow the valuation gap with its US rival, not least because Morgan Stanley’s large investment bank will generate earnings uncertainty. Investors should sit back and enjoy the ride.