Charles Schwab Earnings Preview: Robust Trade Volumes Could Lead To A Profitable Q3

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Charles Schwab

Charles Schwab (NYSE:SCHW) is expected to announce its third quarter earnings on Thursday, October 15. The brokerage firm has enjoyed a sustained period of high trade volumes in Q3, with the total number of trades up by 15% on a year-over-year basis to 539,000 trades per day through the September quarter. Correspondingly, daily average revenue trades (DARTs) were also about 12% higher than the comparable prior year period at 302,000 trades per day. Schwab’s revenues witnessed a modest 5% annual increase to just under $3.1 billion through the first half of the year, with meaningful growth coming from its asset management division and net interest revenues. On the other hand, relatively subdued trading activity through the first half of the year led transaction-based revenues to decline by about 6% y-o-y to $430 million. Since Schwab’s trade volumes through the September quarter have increased sequentially from Q2 levels and are higher on a y-o-y basis, trading commission revenues could boost top line figures for the quarter. Moreover, a higher realized revenue per trade through the quarter could further contribute in terms of both revenue growth and enhanced profitability. Top line growth is likely to translate directly to healthier margins since most expenses incurred by brokerage firms are fixed in nature.

We have a $30 price estimate for the company’s stock, which is slightly higher than the current market price. Schwab’s stock has traded between $26 and $35 this year.

See our full analysis for Charles Schwab

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Trade Volumes Pick Up After Slow First Half

Charles Schwab observed an average of about 313,000 trades per day in the March quarter, which was about 7% lower than prior year levels. Subsequently, the company reported about 267,000 revenue trades per day (out of 490,000 trades per day) in the June quarter. DARTs in Q2 were about 3% lower than the previous year period despite a higher number of total trades through the quarter. As a result, Schwab’s revenues generated by the trading commission business for Q1 and Q2 combined were about 6% lower than the prior year quarter at $430 million. Total trade volumes picked up significantly in the third quarter, with 539,000 total trades per day through the quarter. [1] Similarly, the company reported about 302,000 DARTs in Q3, with August volumes driving growth. If trade volumes stay at Q3 levels through the end of the year, it could lead to average implied quarterly trades per account of 2.3. We currently have a conservative forecast for the average implied annualized trade per account for the full year of 8 trades per account.

Net Interest Yield To Sustain Growth

Charles Schwab ended 2014 with an average interest-bearing asset balance of $138 billion for the full year. The average balance in August 2015 was significantly higher than the 2014 average at just over $160 billion. [2] Schwab’s average balance through August was about 16% higher on a year-over-year basis. We forecast Schwab’s total interest-earning assets to end the current year at an average balance of about $154 billion, and subsequently expect average interest-earning assets to grow at 10% annually for the next few years.

The net interest yield on deposits, securities and loans witnessed a steady decline from 4.61% in 2007 to 1.52% in 2013. The decline in the last few years can be attributed to Fed policies such as the quantitative easing program. However, the trend reversed in 2014, as the yield on these assets started increasing in Q1 last year. Schwab ended 2014 with an average implied yield of 1.64%. However, yields this year have been flat over 2014 levels at around 1.60%. We expect the net interest yield to begin to rise in late 2015 and more steeply in the next couple of years, which could boost Schwab’s net interest revenues.

Margins Could Improve With Revenue Growth

According to our estimates, Schwab’s adjusted EBITDA margin rose from 32.2% in 2010 to 38.2% in 2014. However, limited revenue growth in Q1, complemented by higher cash operating expenses through the quarter, led EBITDA margins to compress by almost 3 percentage points over the prior year period to 35.3%. Subsequently, most cash operating expenses remained flat over the prior year period in Q2. As a result, Schwab’s adjusted EBITDA margin expanded by 120 basis points over the year-ago period to 39.7%. For the first two quarters of 2015, Schwab’s adjusted EBITDA margin stood at about 37.5%, which is a percentage point lower than the comparable prior year period. For Q3, growth in trade volumes could lead to higher revenues for the quarter. A limited increase in cash operating expenses would translate to healthier margins for the company. We currently forecast Schwab’s adjusted EBITDA margin to stand at 39% for the full year, and gradually rise to about 41% through the end of our forecast period.

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Notes:
  1. Charles Schwab Corporation Recent Client Trading Activity Report, Charles Schwab Investor Relations, October 2015 []
  2. Schwab Monthly Metrics for August, Charles Schwab Investor Relations, September 2015 []