Growth In Trading And Client Assets Drives Strong Quarter For Charles Schwab

Charles Schwab (NYSE:SCHW) announced its quarterly results on April 15, reporting a 15% annual increase in revenues. The brokerage firm reported a double-digit year-over-year (y-o-y) growth in its major revenue streams during the quarter- net interest revenues (+18%), asset management and administration fees (+11%) and trading revenues (+11%). The strong growth in revenues was more than what the company had anticipated at the end of the previous quarter. Moreover, the company was able to manage expenses well, and saw a 58% jump in its net income.

The strong Q1 earnings signal the start of what could be a very profitable year for brokerages. Going forward, we expect Charles Schwab to continue to attract new customers, which should contribute to a larger client asset base and net interest revenues for the company. Additionally, we expect Schwab’s transaction-based business to continue to improve over the course of this year. We have price estimate of just over $25 for the company’s stock, which is in line with the current market price.

See our full analysis for Charles Schwab

Growth In Net Interest Revenues And Asset Management Fees

Charles Schwab’s net interest yield on deposits, securities and loans has declined steadily from 4.6% in 2007 to about 1.5% in 2013. The decline in the last few years can be attributed to Fed policies such as  QE. Although the y-o-y growth in interest-earning assets was only about 9% – compared to 20% in the prior year quarter – the yield increased to 1.62% for the quarter, in line with our expectations. Going forward, we remain optimistic about the net yield on interest earning assets, owing to the QE tapering initiatives taken by the Fed. According to our forecasts, the net yield on interest earnings assets could hit the 2% mark by the end of the year for the company.

Charles Schwab’s asset management and administration fees consist of two sub-segments – investor services and advice solutions. The investor services segment provides retail brokerage and banking services to individual investors, retirement plan services, and corporate brokerage services. Advice solutions include separately managed accounts, customized personal advice for clients and full-time portfolio management. Revenues generated by investor services were nearly flat compared to the prior year quarter due to an increase in fee waivers for money market funds, from $155 million in Q1 2013 to $185 million in the last quarter. Comparatively, the advice solutions segment grew by over 22%. We expect the yield on managed assets to remain nearly constant from last year as Schwab has increased its fee waivers, partially offsetting the growth in advisory solutions and asset management fees.

Rising Trading Activity Signals Healthy Market Environment

In the few years prior to 2013, one of Charles Schwab’s biggest areas of concern was a decline in trading activity. In the last few quarters, however, both the number of brokerage accounts as well as trading activity per account have increased, leading to higher revenue generation for the company’s core trading division. Schwab added about 260,000 new brokerage accounts during the quarter, taking the number of active accounts up to 9.2 million. More importantly, the daily average revenue trades were up to 330,000 trades per day – a 14% sequential and a 13% year-over-year increase. Given the improving macroeconomic conditions and a robust trading environment, we expect trading activity to stay healthy in the coming quarters.

Margin Growth Was In Line With Our Expectations

Margin improvement was a major factor that drove Charles Schwab’s performance in the quarter. In line with our expectations, the brokerage’s EBITDA margin jumped by over 8 percentage points compared to the prior year quarter to reach 38.6%. A similar margin improvement was observed in Q3 and Q4 2013 as well, when margins touched almost 38% for the first time since 2008. The trend could also continue in 2014 as revenues continues to grow. Most of Charles Schwab’s costs are fixed in nature, which generally allows revenue growth to directly impact the bottom line. Based on the trends of the last three quarters, we project a nearly 3% improvement in the company’s EBITDA margin for the full year.

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