E*Trade Earnings Preview: Asset-Based Revenues Likely To Sustain Growth

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

E*Trade Financial (NASDAQ:ETFC) is scheduled to announce its Q2 2015 earnings on Thursday, July 23. [1] Although trading activity in the second quarter has been lower than Q1 levels, volumes were roughly flat over the prior year quarter. A slightly higher implied revenue earned per trade could significantly boost trading commission revenues. Moreover, the brokerage has sustained growth in adding net client assets, with the average client balances standing at over $47 billion by the end of May. As a result, even at relatively low yields (which may continue through the latter half of the year) E*Trade could post meaningful top line growth.

We have a $23 price estimate for E*Trade’s stock, which is about 20% lower than the current market price. E*Trade’s stock price has risen by over 25% since the beginning of the year.

See our full analysis for E*Trade Financial

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Slight Improvement In Trading Metrics

E*Trade successfully added over 38,000 net new brokerage accounts during the March quarter, and also added almost 16,000 net new accounts on its trading platforms in April and May combined. 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.

E*Trade reported DARTs of about 157,000 through April and about 151,000 trades per day in May. Trade volumes were roughly flat over the comparable prior year period. 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. However, if volumes stay at Q1 levels (~170,000 trades per day) for the full year, average implied trades per account could rise to over 14.

Asset-Based Revenues To Sustain Growth

E*Trade earns interest income on client assets 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 for April and May were about 5% higher than the year-ago period at over $47 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%. However, the implied annualized yield on these assets in the most recent quarter stood at about 2.61%, which was roughly flat over the 2014 average. As a result, the company’s net interest revenues were only about 3% higher than the year-ago period at $271 million. We currently forecast the average yield for the year to be around 2.86% and to grow to over 3.35% by the end of our forecast period.

Impact On Margins

E*Trade’s cash operating expenses in Q1 were about 4% higher than the prior year quarter at $275 million, while total operating expenses rose by over 3% y-o-y to $300 million. As a result, operating income was about 16% lower than the comparable prior year period at $151 million. According to our estimates, E*Trade’s adjusted EBITDA margin declined by about 5 percentage points from 43.6% in Q1’14 to 38.6% in Q1’15, driven by declines in trading revenues and a rise in employee compensation expenses. The company expects expenses to rise in the mid single-digits through 2015, owing to the anticipated increase in headcount due to an expected rise in trading activity. However, margins could improve on a y-o-y basis as trading activity picked up slightly in the June quarter.

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Notes:
  1. E*TRADE Financial Corporation Announces Second Quarter 2015 Earnings Conference Call, E*Trade Investor Relations, July 2015 []
  2. E*Trade Monthly Metrics For May, E*Trade Investor Relations, June 2015 []