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Charles Schwab (NYSE:SCHW) released its Q4 2013 and FY 2013 earnings on January 16. As expected, the company reported an impressive rise in revenue (+18% in Q4, +11% in FY 2013) and net income (+51% in Q4, +15% in FY 2013). The results were driven by all major business segments – in Q4, asset management fees grew 13%, while net interest revenue and trading revenue grew by 23% and 14% respectively. Like last time, the growth in asset management fees and net interest revenue was driven by an increase in client assets, while trading revenue was positively impacted by a rise in the number of brokerage accounts. The company also seems to have been successful in increasing its profitability – its EBITDA margin increased from 33.6% in 2012 to 35.1% in 2013. 
Given the continued increase in revenue and a higher than expected improvement in operating margins, we are revising our price estimate for the company’s stock from around $20 per share to almost $25 per share. Our price estimate is slightly below the current market price.
All Revenue Streams Are Growing
As highlighted in our pre-earnings note, Schwab has continued to do an impressive job in attracting new clients and assets onto its platform in Q4 2013. Overall, it opened around 250,000 new brokerage accounts in this period, and the tally of client assets on its platform reached an all-time high of $2.25 trillion at the end of December. The net new asset tally also remained positive despite a one-time $30 billion outflow related to the exit of a mutual fund clearing client. We see no reason why the company’s pace of asset gathering should slow down over the next few years, and therefore forecast its asset base to almost double by the end of this decade. Given its historical record in attracting new clients, we also expect the number of active brokerage accounts on Schwab’s platform to reach almost 11.4 million in 2020 from around 9.1 million currently.
A larger asset base is likely to boost Schwab’s asset-based revenues such as net interest income and asset management fees. Over the past few years, asset management fees has been growing on the back of higher demand for advice-based solutions, but net interest income has remained negatively impacted by the low interest rate environment. That may soon change, however, as the Fed has started tapering its quantitative easing program. QE is considered a tailwind for the country’s economy, but it negatively impacted the net interest margins of brokerages because net interest margins are highly correlated with benchmark interest rates. With the commencement of the QE tapering, we expect interest rates to start increasing gradually and boost Schwab’s net interest income. In Q4 2013, the net interest margin on Schwab’s assets increased over the year-ago period for the first time since at least Q2 2012.
The increase in brokerage accounts is also positive for Schwab’s trading commission revenue. This income stream has been suffering over the past few years due to investor activity, but an increasing number of client relationships has ensured that total trading volumes on Schwab’s platforms continue to grow even if the number of trades executed in a typical client remains suppressed. In 2013, the total number brokerage accounts on Schwab’s platform increase 3.5% to reach 9.1 million.
Margin Growth Was Above Our Expectations
Margin improvement was another major factor that drove Charles Schwab’s performance in 2013. According to our calculations, the brokerage’s EBITDA margin jumped almost 150 basis points last year to reach 35.1%, greater than our previous expectations. Most of the margin improvement came in Q3 and Q4, when margins touched almost 38%. The trend could also continue in 2014 as revenue continues to rise. Most of Charles Schwab’s costs are fixed in nature, and this is likely to ensure that Schwab’s margins keep expanding as its revenue increases. Currently, we project a 100 basis point improvement in the company’s EBITDA margin over the next year. However, if it is able to maintain an EBITDA margin of 38%, there could be an upside of almost 5% in our price estimate for the company’s stock.Notes:
- SCHWAB REPORTS FOURTH QUARTER NET INCOME UP 51% YEAR-OVER-YEAR, Charles Schwab, January 16, 2014 [↩]