Morgan Stanley’s $800,000 contingent income autocalls on Exxon: value based on dividends

By Emma Trincal

New York, April 21 – Morgan Stanley Finance LLC’s $800,000 of contingent income autocallable securities due April 20, 2022 linked to the common stock of Exxon Mobil Corp. offer an attractive value for investors seeking to bet on the recovery of the economy and plunging oil markets. But advisers were put off by the idea of giving up an exceptionally high dividend. The ability and willingness of the company to continue to pay its dividends during a crisis will determine the true value of the notes, they said.

The notes will pay a contingent monthly coupon at an annual rate of 13.08% if the stock closes at or above its 65% downside threshold on the determination date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the stock closes at or above its initial share price on any determination date after one year.

The payout at maturity will be par unless the stock finishes below its 65% downside threshold, in which case investors will be fully exposed to any losses.

Credit, fee

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, said the deal would have been attractive if the opportunity cost associated with the non-payment of dividends had not been so high.

“The issuer is Morgan Stanley...I have no problem with their credit,” he said.

“In terms of pricing, it’s a pretty substantial commission.”

The fee is 3%, according to the prospectus.

High dividend

But overall, the key issue for investors considering the deal is the 8.45% dividend they must forgo.

“It does not make a lot of sense to buy the note versus buying the shares outright,” he said.

The share price dropped 42% for the year from $71, closing at $41 on Tuesday.

“If it was a modest dividend, this note would have been a very great value play. But it’s not,” he said.

“I suppose the benefit of this product is its 35% downside protection. But your upside is capped.”

Since investors are not getting the dividends, the actual return is only the coupon minus the yield, or 4.63%, he noted.

“So, you would accept this modest return in exchange for the 35% barrier,” he said.

“I don’t really like the risk-return.

“I’d rather own the stock as a value play.

“It might not recover in six months or in 12 months. But this is one of the best oil companies in the world. It was the largest stock in terms of market capitalization on the New York Stock Exchange. There’s definitely a lot of upside potential and the price is right.”

Cash management

This adviser’s opinion on the note would change if the company decided to cut its dividend. But given its history, it appears unlikely, he noted.

“It looks like the company wants to retain cash to pay its dividend,” he said.

He was referring to an April 7 press release in which Exxon Mobil said: “our objective is to [...] preserve cash for the dividend and make appropriate and prudent use of our balance sheet.”

Demand down

Foldes would buy the stock rather than the note because he believes the current crisis will be over sooner than later.

The recent oil sell-off is the direct result of the coronavirus pandemic and the ensuing social distancing, which is dragging down oil consumption, he explained.

“The share price may be down for a while due to the excess supply. But most of this crisis is due to the coronavirus.

“Once we have a solution to this with possibly a vaccine, once this health crisis is over, we will have our lives back.

“There may be changes in the way people work.

“But everyone will be travelling, flying, cruising and driving again. The economy will be back.”

Oil glut

Another source of price pressure on oil stocks is on the supply side of the oil market.

On Monday, front-end West Texas Intermediate crude contracts fell into negative territory. The anomaly was due to a saturation of storage, making the price of nearby-delivery futures crude oil contracts much more expensive than longer-dated ones.

“The significance of the decline was probably overblown by media coverage given that longer-dated futures were impacted far less severely,” wrote Morningstar analyst Dave Meats in a note on Monday.

Foldes agreed.

“This too is temporary,” he said.

While related to reluctance from some oil producing countries to cut output as well as excess oil supply in the United States, the plunge into negative prices is also a result of a collapsing demand, he noted.

Solid protection

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked the notes for a range bound outlook.

First, the downside protection was attractive, in his view.

“It priced at a low level. To think that a couple of years from now it would go down another 35% is hard to envision short of the entire oil market being supplanted by another source of energy, which is unlikely,” he said.

Not for bulls

It’s more on the upside that investors may be at risk, at least some among the most bullish.

“If you’re a roaring bull, if you think that in two years the stock could go up to $75, then you shouldn’t buy those notes of course.”

He mentioned this price in relation to Morningstar’s fair value estimate of $76 a share for the stock.

“Oil prices are down because of the coronavirus. This market is going to recover,” said Kalscheur.

Calls on the rebound

For this adviser, assessing the suitability of the notes comes in two steps.

“First you have to ask yourself: will Exxon go out of business in two years? Chances are the answer is no.

“Then comes the next question: how soon and how strongly will it recover?

“If you see the stock price doubling in two years, then don’t buy the notes. But if in your view, it’s not going anywhere, if it could move sideways up or down, then it makes sense.

“It’s more likely that you would get called in one year. You put 13% in your pocket. That’s not bad,” he said.

Play it safe

For Kalscheur, the note is a more defensive way to get exposure to the stock than buying the shares outright.

“It’s a conservative oil play.

“The upside is not nearly as good as what you could get with the stock.

“But you have a significant downside protection.

“And 13% is nothing to sneeze out,” he said.

Dividend payments

However, tolerating the non-payment of dividend was the third test for investors.

“Your upside compared to the stock is really less than 5% if you subtract the dividend,” he said.

“Will they continue to pay? That’s the key question.”

“I’d be interested to see how their dividend holds up.

“For sure, if they cut the dividend, you certainly made the right call in going into this structured note.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent with distribution through Morgan Stanley Wealth Management.

The notes priced on Friday and settled on Tuesday.

The Cusip is 61770FP75.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.