E*Trade Earnings Preview: Growing Asset Base, Recovering Trade Volumes To Drive Results

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ETFC: E*TRADE Financial logo
ETFC
E*TRADE Financial

E*Trade Financial (NASDAQ:ETFC) is scheduled to announce its Q3 2014 earnings on Tuesday, October 21. In the second quarter, E*Trade’s asset-based business grew by 11% year-on-year (y-o-y) to $270 million, while low trading volumes kept trading commission revenues flat over the prior year quarter at $105 million. Since E*Trade exited its G1X market making services business in Q1, the brokerage posted flat net revenues over the prior year quarter at $438 million. [1]

We have a $21 price estimate for E*Trade’s stock, which is about 10% higher than the current market price.

See our full analysis for E*Trade Financial

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Growing Customer Base Despite Subdued Trading Activity

E*Trade added nearly 120,000 net new accounts from January through August to take its total active brokerage accounts to 3.12 million. [2] Comparatively, the brokerage added only about 95,000 net new brokerage accounts in 2013, ending the year with just under 3 million accounts. As a result of adding new accounts at a robust rate, E*Trade’s client assets increased by 11.4% y-o-y to $41 billion by the end of June. Moreover, E*Trade’s total client assets (customer assets in brokerage accounts and banking accounts combined) stood at $290 billion at the end of Q2, up from $232 billion in 2013.

Despite a growing customer base, E*Trade’s daily average revenue trades (DARTs) declined by 9% y-o-y to 154,000 trades per day in July. The figure declined sequentially by 5% to 146,000 trades per day in August, though it was nearly flat over August 2013 levels. E*Trade’s transaction-based revenues stayed at prior year levels in Q2, as low trading volumes were offset by a slightly higher realized revenue per trade. The implied revenue per trade – calculated by dividing the net revenue generated by trading commissions by the total number of trades conducted – was $11.13 in 2013. This figure declined to about $10.60 in the March quarter before improving slightly to $10.70 in Q2, which the company mainly attributed to a higher mix of options traded compared to equity trades on E*Trade’s platform. An increasing mix of derivatives traded could help improve the average commission per trade for the brokerage.

Yields and Net Interest Revenues To Rise

E*Trade’s interest-earning assets declined by over 8% from 2012 to $40 billion in 2013 primarily due to deleveraging to pay back debt of the parent company. The yields on interest-earning assets have been low for most brokerage firms and financial institutions over the last few years due to the low interest rate environment. However, E*Trade’s net interest-earning assets grew by around 2% y-o-y to around $41.4 billion in Q2 and the yield on these assets improved by 20 basis points to 2.61%. Consequently, the brokerage generated $270 million in net interest revenues – an 11% increase over the prior year quarter. We expect net interest-earning assets to grow at a CAGR of over 5% for the next few years as the company continues to attract more clients to its trading platform. We currently forecast E*Trade’s interest earning assets to grow to about $60 billion through the end of our forecast period.

Increase in Trade Volumes Could Help Improve Margins

E*Trade’s operating expenses have been flat on a sequential and y-o-y basis in the past few quarters barring a few exceptional items. For instance, the company’s advertising expenses stood at $33 million in Q2 – about 45% higher than the prior year quarter. Management attributed this to advertising costs related to its newly launched platform, branded Type E. Management mentioned that the company does not expect these expenses to recur in the latter half of the year, due to which full-year operating expenses could be only about 10% higher than those in 2013.

We estimate that E*Trade’s adjusted EBITDA margin declined by about 3 percentage points from over 44% in Q1 to 41.1% in Q2. However, the EBITDA margin was significantly higher than the prior year quarter. The slight decline in trading volumes during the quarter was partially responsible for the sequential decline in margins. As trading volumes recover in the latter half of the year, complemented by rise in yields on interest-earning assets, margins could improve from Q2 levels. We have a conservative forecast for the company-wide EBITDA margin of around 40.6% in 2014, while we expect it to increase gradually through the end of our forecast period.

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Notes:
  1. E*Trade Q2 2014 Earnings Call Transcript, Seeking Alpha, July 2014 []
  2. E*Trade Monthly Metrics For August, E*Trade Investor Relations, September 2014 []