E*Trade Earnings Preview: Trade Volumes Rise In Q3 After A Slow First Half

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

E*Trade Financial (NASDAQ:ETFC) is scheduled to announce its Q3 2015 earnings on Thursday, October 22. [1] Trading activity picked up in the third quarter after a slowdown in Q2. A slightly higher implied revenue earned per trade could significantly boost trading commission revenues. However, the brokerage witnessed limited growth in adding net client assets, with the average client balances standing at $46.3 billion by the end of August. Average client balances were about 1% lower than the comparable prior year period. Moreover, relatively low yields – which are likely to continue through the latter half of the year – could hinder growth in asset-based revenues for E*Trade.

We have a $24 price estimate for E*Trade’s stock, which is slightly lower than the current market price. E*Trade’s stock price has risen by over 10% since the beginning of the year.

See our full analysis for E*Trade Financial

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Surge In Trade Volumes

The total number of brokerage accounts at E*Trade stood at just over 3.2 million accounts at the end of August. E*Trade has added about 60,000 net new accounts through 2015 thus far. ((E*Trade Monthly Metrics For August, E*Trade Investor Relations, September 2015)) However, the company added only about net new 3,000 accounts for July and August combined. 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’s daily average revenue trades (DARTs) stood at about 170,000 trades per day in Q1, and fell to just under just under 150,000 in the June quarter. Complementing the rise in brokerage accounts, E*Trade witnessed a 21% sequential rise in trade volumes to just under 180,000 trades per day in August. In the most recent 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 the prior year quarter 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. After a slow mid-year period, E*Trade’s DARTs stood at nearly 180,000 through August, which was about 23% higher than prior year levels. [2]

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 July and August were about 1% lower than the year-ago period at just over $46 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 current year to be around 2.71%; as a result, net interest revenues could be around 5% higher than the prior calendar year.

Impact On Margins

 According to our estimates, E*Trade’s adjusted EBITDA margin stood at just over 40% through 2014, significantly higher than 2013 levels of about 32.5%. 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 in 2014 led to healthier margins. Subsequently, low trade volumes and resulting revenues in the first half of 2015 has caused 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 contribute to healthier margins are improved yields on client assets and a rise in trading activity in the second half of the year. With high trade volumes in Q3, 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 Financial Corporation Announces Third Quarter 2015 Earnings Conference Call, E*Trade Investor Relations, October 2015 []
  2. E*Trade Monthly Metrics For August, E*Trade Investor Relations, September 2015 [] []