Schwab’s Results Are Not As Bad As They Appear
Charles Schwab (NYSE:SCHW) reported its earnings for Q2 2013 on July 16. The company’s net revenue grew 4% from the same period last year to reach $1,337 million. Since the revenue for Q2 2012 was artificially boosted by a one-time pre-tax gain of $70 million relating to the resolution of a vendor dispute, the year-on-year growth in net revenue would actually be higher – almost 10% – if we make an adjustment for the same.
All major divisions contributed to revenue growth as asset management fees, net interest revenue and trading revenue were up year-on-year by 15%, 3% and 7% respectively. Asset management fees were driven by increases in average client assets across Schwab’s product line while the growth in net interest revenue was primarily due to higher average balances in interest earning assets. Trading revenue was up on the back of a 24% year-on-year increase in daily average revenue trades (DARTs).
Similar to revenue, Schwab’s net income growth would also look higher if we make an adjustment for the one-time gain discussed above. The company’s “reported” net income decreased from $275 million in Q2 2012 to $256 million in the most recent quarter. However, the Q2 2012 figure would be only $231 million if we adjust it by $44 million ($70 million pre-tax gain equates to $44 million after-tax income according to Schwab), implying that the company’s net income actually rose by 11% on year-on-year basis.
See our full analysis for Charles Schwab
Asset Gathering Momentum Intact
From an operating metrics standpoint, Schwab’s asset gathering stumbled just like we predicted. The company’s total client assets declined by almost $34 billion to reach $2,051 billion at the end of June, partly due to market losses and partly because the company lost a large mutual fund clearing client. However, Schwab did not lose this client to a competitor and the loss happened only because the client chose to maintain the assets in-house. This is a one-time shock and the affect should wear off in the coming quarters. Long term asset gathering momentum seems intact as Schwab’s advisor services division attracted $13.6 billion in net new assets, up from $10.6 billion in the year-ago quarter.
Net Interest Revenue Also Up Despite Rate Compression
Net interest revenue is the largest source of value in Charles Schwab according to our estimates, and the segment seems to be performing well despite the tough interest rate scenario. This is largely because average balances in interest earning assets have continued to soar – average balance in interest earning assets increased by 20% from $106 billion in Q2 2012 to $128 billion in the most recent quarter. Going forward, we see no reason why this trend should reverse and believe that higher average balance position the company in such a way that it will benefit from an eventual increase in interest rates.
Higher Trading Volumes Is A Welcome Change
On the trading business front, the company seems to be slowly recovering from the exceptionally low trading volumes of 2012. After a 17% year-on-year rise in May, daily average revenue trades registered a 24% year-on-year increase in June. This is a positive sign for Schwab’s transaction-based revenue, and we believe that the company’s trading commission revenue could be back on the growth track much sooner than anticipated if volumes continue to increase at this pace in the coming quarters.
Our new price estimate for the company is $18, around 10% below the current market price.
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