Trade Volumes, Limited Growth In Asset Base To Weigh On E*Trade’s Earnings

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

E*Trade Financial (NASDAQ:ETFC) is scheduled to announce its Q4 fiscal 2015 earnings on Thursday, January 21. Trading activity for the brokerage remained suppressed for most of 2015 compared to the previous year. We believe that the downtrend in daily average revenue trades (DARTs) seen in October and November likely continued in December, resulting in a lackluster quarter for transaction revenues. Conversely, total interest earning assets at the brokerage grew, although marginally, in October and November to $47 billion. And with the Fed’s decision to hike interest rates underway, we expect the growth momentum to have continued in December, boosting the net interest income earned by the brokerage firm in 2015.

We have a $24 price estimate for E*Trade’s stock, which is in line with the current market price.

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See our full analysis for E*Trade Financial

Trade Volumes To Remain Subdued

E-Trade decided to shut down its brokerage operations in Hong Kong and Singapore, in addition with its global trading platform, in Q2. [1] This led to a considerable drop in additions of net new brokerage accounts in September and October. However, the metric rebounded in November, with 7,300 new accounts through the month. Subsequently, brokerage accounts at the end of the period stood at 3.21 million. We expect E-Trade to have continued the addition of new brokerage accounts in December, to end the year at around 3.26 million brokerage accounts.

Trade volumes witnessed limited growth in 2015, only increasing in August. As a result, for the nine month period through September, daily average revenue trades (DARTs) declined by 6% year over year (y-o-y) to 158,326 trades per day. In contrast, the average commission per trade increased by 1% y-o-y to $10.92 in the same period, and transaction revenue fell by 5% y-o-y to $325 million. ((E*Trade Quarterly Report, E*Trade Investor Relations, October 2015)) In October, DARTs dropped by 18% y-o-y to 145,000, and this slowdown sustained through November. However, we expect December volumes to have rebounded somewhat, limiting the downside for transaction revenue.

Marginal Growth In Asset Backed Revenues

E*Trade’s average client balances were $41.3 billion for the nine month period ended September, approximately 1% lower than the year ago period. However, in the first two months of the fourth quarter, progress was made in accretion of interest earning assets, which grew to $47 billion. [2] Consequently, we expect average client balances to have improved in December, ending the year 2015 with assets worth nearly $42 billion.

In 2014, the net yield earned on interest earning assets rose for the first time after the financial crisis to 2.63%. As a result, net interest income increased by 11% y-o-y to 1.1 billion in 2014. However, due to a weak global economy and the Fed’s decision to push the rate hike to later in the year, net yields in 2015 didn’t exhibit any growth. Correspondingly, for the first three quarters of 2015, net interest income increased only by 1% y-o-y to $801 million. [3] We project the net interest yield earned on loans, deposits and securities to remain stagnant in 2015, beginning to ascend in early 2016.

Margins To Decline In 2015

Low trading activity in 2015 led to a 5% decline in trading commission revenues through the nine month period ended September. Moreover, stagnant yield levels resulted in no meaningful rise in E-Trade’s interest revenues. As a result, the company’s adjusted EBITDA margin for the company was 38.6% in Q3, about 3 percentage points lower than the prior year period. We expect the aforementioned factors to weigh on the company’s margins in Q4 as well, and thus forecast them to remain at 38.6% for the full year, down from about 40% in 2014. However, with the interest rate hike implemented by Fed, we expect EBITDA margins to improve in the coming years and reach 45% by the end of the decade.

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Notes:
  1. Earnings Call Transcript for Q3 2015, E*Trade Investor Relations, October 2015 []
  2. E*Trade Monthly Metrics For November, E*Trade Investor Relations, December 2015 []
  3. E*Trade Quarterly Report, E*Trade Investor Relations, October 2015 []