Charles Schwab Earnings Preview: Asset-Based Revenues To Maintain Growth

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Charles Schwab

Charles Schwab (NYSE:SCHW) is scheduled to announce its fourth quarter earnings on January 16. Schwab’s revenues grew by 13% year-on-year (y-o-y) to nearly $1.5 billion in the third quarter, driven by an 11% and 13% annual increase in asset management fees and net interest revenues, respectively. On the other hand, transaction-based revenues were down by 7% y-o-y to $209 million during the quarter due to a slump in trading activity. Similarly, net revenues through the first three quarters of 2014 were up by 13% over the prior year period to $4.5 billion, with net interest revenues and asset management fees driving much of the growth. Trading commission-based revenues declined by over 2% y-o-y to $668 million through the first three quarters of 2014.

Most of Schwab’s year-to-date operating expenses, including communication, advertising and occupancy, stayed at prior year levels through the first three quarters at a combined $845 million. However, compensation and professional services expenses rose by almost 9% y-o-y to $1.6 billion and $335 million. As a result, the company’s total operating expenses increased by about 7% to $2.8 billion in 2014 year-to-date. Comparatively, net revenues generated by the brokerage have grown by 13% to $4.5 billion from January through September. As a result, Schwab’s net income has increased by nearly 30% to $971 million. According to our estimates, Schwab’s adjusted EBITDA margin rose from 32.2% in 2010 to 35.1% in 2013. This has further improved from Q1 through Q3. With the growing client asset base under management and rising interest rates, the brokerage’s EBITDA margins could continue to improve in the long run. We have a $27 price estimate for the company’s stock, which is slightly lower than the current market price.

See our full analysis for Charles Schwab

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Trading Activity Flat Over 2013

Schwab’s trading commissions picked up in Q1 after a slump in recent years. The daily average revenue trades (DARTs) in Q1 were up to 330,000 trades per day, a 13% year-over-year increase. After the surge in trade volumes at the beginning of the year, trading activity was subdued through Q2 and Q3. Schwab witnessed a 9% y-o-y decline in trading volumes to 274,000 trades per day in the quarter ending June and a 5% y-o-y decline Q3 trade volumes to 269,000 trades per day. As a result, Schwab’s DARTs through first three quarters were flat over the comparable 2013 period at 293,000 trades per day. [1] We currently forecast Schwab to end the year at just over 300,000 trades per day. The brokerage nearly 9.4 million trading accounts on its platform, which implies roughly 8 trades per active account per year. With the increase in DARTs, we expect the annual average number of trades per account to gradually increase to over 11 through the end of the decade.

Asset Management Fees, Net Interest Yield Witness Solid Growth

Charles Schwab successfully attracted new client accounts during the past year at a rapid pace of over 80,000 gross and 23,000 net new accounts every month on average. Consequently, Schwab’s total active brokerage accounts at the end of November stood at almost 9.4 million accounts, up from just under 9.1 million accounts at the beginning of the year. [2] As a result of the rise in the number of accounts, Schwab’s total client assets under management were nearly $2.5 trillion at the end of November, up from $2.2 trillion at the beginning of the year. The fees charged on these assets for proprietary and third-party mutual fund offerings and advisory solutions such as equity and bond funds, money market funds and mutual funds grew by 11% over the year-ago period to almost $1.9 billion through the first three quarters of 2014. Much o f the growth was driven by solutions such as full-time portfolio management, separately managed accounts and customized personal advice for tailored portfolios. We currently forecast Schwab’s net client base to continue to grow at 8-9% through the end of our forecast period.

The yield on total client assets under management declined from 0.21% in 2008 to 0.10% in 2013. However, the trend has reversed in 2014, with the yield on these assets increasing to around 0.11% for the period from January through September. We expect the yield to stay at around 0.11% for the full year and subsequently increase in the coming years.

Schwab’s total interest on deposits, loans and securities increased at a CAGR of 18% over the last three years. The growth in net interest-bearing assets continued in 2014, albeit at a slower pace than the last few years. Total interest earning assets including deposits, loans and securities increased at an annual rate of under 8% y-o-y from January through November, with the average balance of interest earning assets staying at over $138 billion. [2] We forecast Schwab’s total interest earning assets to end the year at an average balance of $139 billion for 2014, and subsequently expect average interest-earning assets to grow at 10% annually for the next few years.

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Notes:
  1. Charles Schwab 10-Q, SEC, December 2014 []
  2. Charles Schwab Monthly Report, Charles Schwab Investor Relations, December 2014 [] []