Why E-Trade Is Worth $62

by Trefis Team
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E*Trade Financial (NASDAQ:ETFC) has had a robust first half of 2018, comfortably beating consensus estimates in both quarters, with revenue growth primarily driven by interest earning assets. With the expectation of rate hikes in the upcoming years, we expect significant growth in interest earning assets and related revenues going forward. Improvement in U.S. macro conditions should drive trading volumes and consequently, trading commissions. The acquisition of TCA and 1 million brokerage accounts from Capital One should further boost the brokerage’s customers and asset growth in the future. We have a $62 price estimate for E-Trade, which is higher than the current market price. The various driver assumptions can be modified by accessing our interactive dashboard on Our Outlook For E-Trade In Fiscal 2019, to gauge their impact on the earnings and price per share metrics.

We have arrived at a $62 price estimate for E-Trade based on revenue projections of $3.3 billion for FY 2019, adjusted EBITDA of $1.8 billion, an EBITDA multiple of 9.6x, and a share count of 274 million. The market price stood at $52 as of October 4, 2018, implying our price estimate is higher by 18%.

E-Trade’s generates revenue from three divisions – net interest income, trading commissions, and fees/other. Net interest income is primarily driven by interest earned on investment securities, margin receivables, and mortgage-backed securities and loans. Improvement in the U.S. economy, coupled with interest rate hikes, should contribute to growth company’s interest earning asset base. E-Trade’s acquisition of OptionsHouse in 2016 (fully integrated in 2017), led to robust growth in brokerage’s customers and asset base, and we expect the company to further benefit in the near future. Further, the TCA and Capital One brokerage account acquisitions (expected to be completed by Q4’18) should help lower its customer acquisition costs and drive customer and asset growth.

Net Interest Income accounts for about 63% of E-Trade’s overall revenues. This segment has been the fastest growing segment, with 14% and 17% annual growth between 2015-2017 in interest earning assets and revenue, respectively. The robust growth was attributable to multiple Fed rate hikes, as a result of improvement in U.S. macroeconomic conditions. Further, its net interest yield of 2.8% is the highest amongst its competitors. We expect about 10 basis points in annual yield growth, driven by interest rate hikes and an increase in demand for loans. As a result, we forecast the company’s Net Interest Income to grow by 22% annually going forward.

E-Trade’s acquisition of OptionsHouse in late 2016 helped the brokerage post robust daily average revenue trades (DARTs) in 2017. Moreover, it helped negate E-Trade’s decision to cut its commissions per trade by nearly 40% which would have otherwise led to substantial declines in trading revenues in 2017. Improving macro conditions led to a surge in trading volumes, helping the company offset the impact of its commission cuts. The fee cuts make sense strategically given the competitive pressure, but they will impact the company’s near-term trading revenues. That said, we expect a significant jump in trading volumes and brokerage accounts in the near term owing to the aforementioned acquisitions. In addition, the Capital One transaction should further boost trading volumes and brokerage accounts from 2019 onwards. As a result, we expect the company’s Trading commissions to grow by 15% annually going forward.

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