Sustained Period Of Low Trade Volumes For E*Trade, Stock Worth $23

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

Brokerage firm E*Trade Financial (NASDAQ:ETFC) reported a 4% sequential decline in trade volumes for the month of May. The company recently released its trading metrics for May, reporting 151,000 daily average revenue trades (DARTs) on its platforms, 3% higher over the prior year period. E*Trade continued to improve its average client asset balances, which rose by 4% annually and 2% month-over-month to $47.6 billion by the end of May.

In its most recent earnings, E*Trade reported a 4% year-on-year decline in net revenues to $456 million. The brokerage’s asset-based business grew by 3% year on year  to $271 million while low trading volumes led trading commissions to decline by 10% over the prior year quarter to $114 million. The account maintenance fees and services charged by the brokerage also rose by 4% to $52 million during the March quarter. [1] Below we take a look at some key metrics through Q2’15 and our full year forecasts for E*Trade.

We have a $23 price estimate for E*Trade’s stock, which is significantly lower than the current market price. E*Trade’s market price has risen by over 25% since the beginning of this year.

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See our full analysis for E*Trade Financial

Continued Growth In Net Client Assets

E*Trade earns interest income through holding credit balances, which include margin, real estate and consumer loans and by holding customer cash and deposits. The company’s average client balances for brokerage accounts through May were 4% higher than the year-ago period at $47.6 billion. [2] We forecast E*Trade’s average client balance for the full year to be 6% higher than 2014 levels at about $44 billion. Subsequently, we forecast the average balances to rise to over $55 billion through the end of our forecast period.

Last year, the net yield on these assets rose for the first time in over five years, due to which revenues generated by interest on these balances grew by 11% year over year  to $1.1 billion. The implied yield on these assets was 23 basis points higher than the prior year period at 2.63%. We currently forecast the average yield for the current year to be around 2.86% and resulting revenues to be 15% higher than the prior calendar year at just under $1.3 billion.

Limited Rise In Trade Volumes

E*Trade successfully added over 38,000 net new brokerage accounts during the March quarter. The company has witnessed a moderate increase in total accounts through Q2 as well. E*Trade has added almost 16,000 net new accounts on its trading platforms in the June quarter thus far. The total number of brokerage accounts at E*Trade stood at almost 3.20 million accounts at the end of May, about 3% higher than the year-ago period. ((E*Trade Monthly Metrics For May, E*Trade Investor Relations, June 2015)) We currently forecast the total number of brokerage accounts at E*Trade to increase to 3.27 million by the end of 2015, and to over 4 million through the end of our forecast period.

Comparatively, E*Trade witnessed an 11% year-on-year decline in trade volumes through the March quarter to about 170,000 trades per day. However, the brokerage witnessed an annual decline in volumes mainly due to a surge in trading activity in the year-ago period (leading to a tougher year-over-year comparison). [3] Continuing the trend, E*Trade reported DARTs of about 157,000 through April, which was over 8% lower than volume in the comparable prior year period. Although volumes declined further to about 151,000 trades per day in May, it was 3% y-o-y increase. In the most recent quarter, E*trade realized a slightly higher revenue per trade compared to the year ago period. As a result, the transaction-based revenue generated by the brokerage for the quarter was down by 10% over Q1’14 to $114 million (compared to the 11% decline in trade volume).

With 3.2 million accounts at the brokerage, 155,000 trades per day roughly translates to an average of over 3 trades per account for a quarter. If the number of trades per day stay at Q2 levels for the full year, it could lead the average annualized trades per account to stay at about 12 trades per account for the full year. Similarly, if volumes stay at Q1 levels (~170,000 trades per day) for the full year, it could lead the average implied trades per account to rise to over 14 trades per account.

Impact Of Revenue Growth On Margins

E*Trade’s operating expenses in 2014 were slightly lower than the previous year at $1.1 billion, while its operating income was up by over 100% year over year to $633 million. Since most expenses incurred by brokerages are fixed in nature, growth in net revenues directly impacts margins. According to our estimates, E*Trade’s adjusted EBITDA margin was over 40% through the year, significantly higher than 2013 levels of about 32.5%. Subsequently, low trade volumes and resulting revenues in the recently ended March quarter led E*Trade’s adjusted EBITDA margin to decline by about 5 percentage points to 38.6% in Q1’15. We currently forecast the company-wide EBITDA margin to rise to about 42% in 2015, while we expect it to increase more gradually through the end of our forecast period.

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Notes:
  1. E*Trade Q1 2015 Earnings Call Transcript, Seeking Alpha, April 2015 []
  2. E*Trade Monthly Metrics For May, E*Trade Investor Relations, June 2015 []
  3. Discount brokers’ volumes rise as small investors pile into stocks, Reuters, March 2014 []