E*Trade Earnings Preview: Volumes And Margins Likely To Continue Improving

by Trefis Team
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E*Trade Financial (NASDAQ:ETFC) is scheduled to announce its Q4 earnings Thursday, January 23. Over the last few quarters, the company has been in the process of reducing the debt of its parent company, which stood at around $1.8 billion at the end of last quarter. In its Q3 earnings call, the company announced improved margins over the same period last year on the back of successful cost reduction measures. Although the company’s net interest revenue declined due to continued yield depression, the overall revenues didn’t suffer as trading commissions increased due to higher trading volumes. [1]

We expect E*Trade’s corporate expenses, which include corporate interest expense, to decline significantly in the upcoming earnings release and beyond due to its debt reduction initiative. Further, its margins are likely to improve as the benefits of cost-cutting start to show (see Here’s Why E*Trade’s Margins Will Continue To Improve). We have a price estimate of $16 for its stock, which is ~20% below the current market price.

See our full analysis for E*Trade Financial

Cost-Cutting Measures

E-Trade’s management intended to reduce costs incurred by the company by more than $100 million in 2013, and accomplished this goal ahead of schedule with a significant number layoffs. [2] Considering that most brokerage firms work on a relatively fixed-cost model, a reduction in costs should directly impact the overall margins of these brokerages. Going forward we expect the company’s EBITDA margins to gradually improve.

Net Interest Income Could Start Recovering

E*Trade has already completed its deleveraging and de-risking initiatives, which included reducing its wholesale borrowings, transferring sweep deposits off its balance sheet to third parties, and directing customer payables and new customer cash to money funds. With the completion of these initiatives, we expect its net interest assets to start growing. Additionally, we expect yields on these assets to start recovering now that the Fed has started tapering its QE program. Both these factors should impact net interest income positively going forward.

Fees And Service Charges Impacted By G1X Sale

The company sold of its market making business, called G1 Execution Services, to Susquehanna International Group, LLP for $75 million in the last quarter. The sale is likely to help the company focus on its core business and customers. [3] Due the sale of G1X, we have changed our model to reflect principal transaction revenue generated falling to zero. On the other hand, the revenue from Fees and Service Charges is expected to increase since more customer trades are being routed to third parties. As part of its agreement with Susquehanna, E*Trade will reroute 70% of customer equity flow to G1X over the next five years.

Growing Trade Volume

Trading commission revenues increased by 13% year-on-year (y-o-y) in Q3, which can be attributed to a 13% increase in number of daily average revenue trades (DARTs) as well as a 3% growth in brokerage accounts. On a month-wise comparison, E*Trade’s DARTs increased by more than 25% y-o-y during the months of October and November. [4] On the back of a healthier macroeconomic environment compared to a few years back, and an improving retail investor sentiment, we expect the trading activity to gradually increase over the next few years.

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Notes:
  1. E*Trade Q3 Earnings Call Transcript, Seeking Alpha, October 2013 []
  2. E*Trade Layoffs Amid Cost Cuts, Wall Street Journal, February 2013 []
  3. E*Trade Sells Market Making Business To Susquehanna, Bloomberg, October 2013 []
  4. E*Trade Monthly Metrics, E*Trade Investor Relations, January 2014 []
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