Weak Trading Activity Continues For E*Trade

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

E*Trade Financial (NASDAQ:ETFC) recently released its trading metrics for July, reporting a 7% sequential rise in trade volumes. The 149,000 daily average revenue trades (DARTs) on its platforms were 3% lower than the prior year period. Despite lower year-on-year volumes for the month, E*Trade continued to improve its average client asset balances, which rose by 2% annually to $46.7 billion by the end of July.

In its most recent earnings, E*Trade reported a modest 1% year-on-year rise in net revenues to $445 million. Comparatively, the brokerage reported a 4% annual decline in revenues through the March quarter. Low trade volumes since the beginning of the year led to limited growth in trading commission-based revenues in the first half of 2015. Similarly, flat yields on assets in Q2 resulted in E*Trade’s interest revenues remaining flat over the prior year period at $267 million despite a mild increase in interest-earning assets. On the other hand, revenues generated by account maintenance fees and services charged by the brokerage have been consistently high this year. ((E*TRADE Financial Corporation Announces Second Quarter 2015 Results, E*Trade Press Release, July 2015)) Below we take a look at some key metrics through Q3 and our full year forecasts for E*Trade.

We have a $23 price estimate for E*Trade’s stock, which is about 10% lower than the current market price. E*Trade’s market price rose from over $22 in January to about $31 in June before trading at around $26 last week.

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See our full analysis for E*Trade Financial

Net Client Assets Higher Than 2014 Levels

E*Trade earns interest income by holding customer cash and deposits in addition to credit balances, which include margin, real estate and consumer loans. The company’s average client balances for brokerage accounts through July were 2% higher than the year-ago period at $46.7 billion. [1] The brokerage reported a full year average client balance of $41.4 billion for 2014. 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 full-year 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 2013 at 2.63%. However, the yield on these assets stood at 2.54% in the most recent quarter. As a result, net interest revenues were flat over the previous year period at $267 million. We currently forecast the average yield for the current year to be around 2.86%; as a result, net interest revenues could be over 10% higher than the prior calendar year at around $1.3 billion.

Limited Growth In Trading Activity

E*Trade added about 146,000 net new brokerage accounts in 2014, ending the year with 3.14 million accounts. The brokerage has successfully added about 50,000 net new accounts in 2015 thus far, ending July with 3.19 million brokerage accounts.The total number of brokerage accounts at E*Trade at the end of July were about 3% higher than the year-ago period. [1] 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.

However, E*Trade witnessed an 11% year-on-year decline in trade volumes through the March quarter to about 170,000 trades per day. The trend continued in the June quarter, with trade volumes falling both sequentially (-12%) and annually (-4%) to just under 150,000 trades per day. The unimpressive streak continued in July, with DARTs staying 3% lower than previous year levels at 149,000 trades per day. In the June quarter, E*trade realized a slightly higher revenue per trade compared to 2014 levels. As a result, the transaction-based revenue generated by the brokerage for the quarter was down by only 2% over Q2 2014 to $103 million (compared to the 11% decline in trade volume). The implied revenue per trade – calculated by dividing the net trading commission revenue by the total number of trades  – was $10.96 during the quarter, compared to $10.72 in the year ago period. [2]

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 first half of 2015 has led E*Trade’s adjusted EBITDA margin to compress. Its adjusted EBITDA margin fell by about 5 percentage points to 38.6% in Q1’15 and over 3 percentage points to 38.9% in Q2. Two key factors that can help the brokerage post healthier margins are improved yields on client assets and a rise in trading activity in the second half of the year. We are currently optimistic in our forecast for the company-wide EBITDA margin. We currently forecast the figure 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 Monthly Metrics For July, E*Trade Investor Relations, August 2015 [] []
  2. E*Trade Q2 2015 Earnings Call Transcript, Seeking Alpha, July 2015 []