Asset-Based Revenues Drive Charles Schwab’s Q4 Results
Charles Schwab (NYSE:SCHW) announced its fourth quarter earnings on January 16, reporting an 8% year-on-year increase in net revenues to over $1.5 billion for the quarter. The growth in net revenues was lower than the three preceding quarters, due to which Schwab’s full year revenues rose by 11% on an annual basis to just over $6 billion. Similarly, interest-based revenues and asset management revenues continued their growth spree in Q4, albeit at a slower pace than the first three quarters. Net interest revenues rose by 10% to $584 million while asset management and administration fees grew by 5% y-o-y to $641 million. On the other hand, Schwab’s trading revenues in Q4 rose by 3% y-o-y to $239 million, after declining in Q2 and Q3. [1]
Furthermore, Schwab’s operating expenses for the quarter grew by about 6% over the year-ago period to $943 million, with compensation and professional services expenses rising by 7% y-0-y to $665 million. Most other expenses remained nearly flat over the prior year levels. Despite a rise in operating expenses, a comparatively higher revenue growth led Schwab’s adjusted EBITDA margin for the quarter to improve by a percentage point over Q4’13 at 39.1%. As a result, Schwab posted a record net income of $350 million, which was almost 10% higher than prior year quarter.
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Asset Management Fees, Interest Revenues Drive Revenue Growth
Charles Schwab’s asset management revenues include the fees that the brokerage charges for its proprietary and third-party mutual fund offerings and advisory solutions such as equity and bond funds, money market funds and mutual funds. Schwab’s total client assets totaled nearly $2.5 trillion at the end of 2014, nearly 10% higher than the year-ago level. The implied yield on total client assets stayed around prior year levels of just over 0.10%. As a result, Schwab’s asset management and administration revenues rose by about 10% in 2014 to $2.5 billion. We forecast Schwab’s total client assets to rise to over $4 trillion by the end of the decade, and the yield to improve to over 0.15% in the same period.
The company’s interest-earning assets grew by almost 5% y-o-y to $138 billion in 2014, as the brokerage successfully added new trading accounts accounts during the year. Schwab ended the year with 9.4 million brokerage accounts. We forecast the total-interest earning assets to increase by 8-9% in the coming years to over $200 billion by the end of the decade. The implied net interest yield on these assets for the full year was about 12 basis points higher than the previous year at 1.64%. We expect the net interest yield to rise more steeply in the next couple of years, which could boost Schwab’s net interest revenues.
Trading Revenues Flat Over 2013 Despite Late Rally
Schwab’s revenues generated by the trading commission business in Q4 were about 3% higher than the prior year quarter at $239 million. However, trading revenues for the full year were slightly lower than 2013 at $907 million owing to low trading volumes in Q2 and Q3. Although Schwab’s daily average client trades and daily average revenue trades for the full year were both slightly higher than 2013 levels at about 517,000 trades per day and 299,000 trades per day, respectively, the average revenue realized per trade was lower than the previous year levels. Despite lower trading revenues for the full year, the company consistently added new brokerage accounts. The company ended the year at nearly 9.4 million active brokerage accounts, up from about 9.1 million active accounts at the beginning of the year. This translates to an average of about 8.0 trades per active account for the full year, which is about 2% lower than 2013 levels. We currently forecast Schwab to continue to grow its customer base to over 12 million brokerage accounts through the end of our forecast period. Correspondingly, we expect trading activity to rise and the average annualized trades per account to increase to over 10 trades per account per year through the end of our forecast period.
Profitability Continues To Improve Through 2014
The company’s total operating expenses for the full year stayed at prior year levels, with the exception of compensation and professional services expenses, both of which rose by about 8-9% y-o-y. The company’s total operating expenses increased by only 6% to $3.7 billion through the year. Comparatively, net revenues generated by the brokerage for the full year grew by 11% to $6 billion. Consequently, Schwab’s net income has increased by nearly 25% to $1.3 billion.
According to our estimates, Schwab’s adjusted EBITDA margin rose from 32.2% in 2010 to 35.1% in 2013. This improved further in 2014 to 38.2%. 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 currently forecast Schwab’s adjusted EBITDA margin to rise to over 41% through the end of our forecast period. You can modify the interactive chart below to gauge the effect a change in EBITDA margin will have on our $25 price estimate for the company’s stock.
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- Charles Schwab Q4 2014 Earnings Press Release, Charles Schwab Press Release, January 2015 [↩]