Charles Schwab Earnings Preview: Low Trading Activity Through Q1’15

Brokerage firm Charles Schwab (NYSE:SCHW) is expected to announce its first quarter earnings on April 15. Schwab’s revenues grew by 11% year-on-year (y-o-y) to over $6 billion in 2014, driven by a 9% and 15% annual increase in asset management fees and net interest revenues, respectively. On the other hand, comparatively lackluster trading activity during the year led transaction-based revenues to be flat relative to 2013 levels at $907 million. Similarly, net revenues in the December quarter were up by 8% over the prior year period to $1.5 billion, with net interest revenues (+10%) and asset management fees (+5%) driving much of the growth. Trading commission-based revenues rose by 3% y-o-y to $239 million, after declining in Q2 and Q3.

Most of Schwab’s operating expenses for the year, including communication, advertising and occupancy, stayed at prior year levels through 2014 at a combined $1.1 billion. However, compensation and professional services expenses rose by 8-10% y-o-y to $2.2 billion and $457 million, respectively. As a result, the company’s total operating expenses increased by about 6% to $3.7 billion for the full year. Comparatively, net revenues generated by the brokerage grew by 11% due to which Schwab’s net income increased by 23% to $1.3 billion. According to our estimates, Schwab’s adjusted EBITDA margin improved by more than 3 percentage points over the previous year to 38.2% in 2014. 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 $25 price estimate for the company’s stock, which is about 20% lower than the current market price. Schwab’s stock price has risen by over 15% since the company reported its Q4’14 earnings in mid-January.

See our full analysis for Charles Schwab

Asset Management Fees, Net Interest Yield Witness Solid Growth

Charles Schwab successfully attracted new client accounts during 2014 at a rapid pace of over 80,000 gross and 23,000 net new accounts every month on average. Keeping up the trend, Schwab added added 84,000 and 80,000 gross new accounts in January and February, respectively. As a result of the rise in the number of accounts, Schwab’s total client assets under management stood at $2.53 trillion at the end of February, up from $2.46 trillion at the end of 2014. ^[1] 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 over 9% over the previous year to $2.5 billion in 2014. Much of 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 reversed in 2014, with the yield on these assets staying flat over the previous year at 0.10%. Despite flat yields over the previous year, Schwab’s asset management fees grew by almost 10% to $2.5 billion in 2014 – mainly due to the growth in the total assets under management. We expect the yield to gradually rise to about 0.11% in 2015 and subsequently increase to over 0.15% through the end of our forecast period. As a result, we expect resulting revenues to be around the $3 billion mark for the full year.

Schwab’s total interest on deposits, loans and securities increased at a CAGR of 19% over the last five years. However, the growth in net interest-bearing assets in 2014 was lower than previous years as the company could only manage a 7% growth in total interest earning assets including deposits, loans and securities. Schwab ended the year at an average interest-bearing asset balance of just over $138 billion. The average balance through January and February has been significantly higher than the 2014 average at over $148 billion.((Schwab Monthly Metrics February, Charles Schwab Investor Relations, March 2015)) We forecast Schwab’s total interest-earning assets to end the current year at an average balance of just about $150 billion, and subsequently expect average interest-earning assets to grow at 10% annually for the next few years.

Trading Activity Lower Than 2014

Charles Schwab observed an average of about 322,000 trades per day in January, 317,000 revenue trades per day in February and 291,000 trades per day in March. As a result, Schwab ended Q1’15 at about 310,000 DARTs in Q1’15, which is about 6% lower than the comparable prior year period but about 4% higher than the 2014 average. ^[2] The brokerage ended February with 9.44 million active trading accounts on its platform – up from 9.39 million at the end of December 2014. We forecast Schwab to add nearly 300,000 net new accounts in 2015.

With the increase in the number of accounts in 2014, Schwab’s annual average implied number of trades per account fell by about 2% to 8 per account. We currently forecast the annual average number of trades per account to increase to about 8.3 in 2015 and gradually rise to over 11 through the end of the decade.

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1. Schwab Monthly Metrics February, Charles Schwab Investor Relations, March 2015 [↩]
2. Charles Schwab Corporation Recent Client Trading Activity Report, Charles Schwab Investor Relations, April 2015 [↩]