Cautious On Charles Schwab’s Earnings On Slow Recovery

Charles Schwab (NYSE:SCHW) will release its quarterly performance figures on the 15^th of April. The company has been able to maintain stable revenue growth over the past several years but lagged its guidance of 8% revenue growth in 2012 by nearly 4%.

During its winter business update, Walt Bettinger II, CEO of Charles Schwab, claimed that the company could achieve a revenue growth of about 10% in 2013 if its baseline scenario — which includes an improvement in trading volumes — plays out. However, we believe that even though trading volumes have improved during the first two months of this year, the improvement is not large enough to justify a 10% y-o-y revenue growth. We are also concerned about Schwab’s slow pace of adding net new accounts compared to its peers and are closely watching its rate of asset gathering.

We expect this earnings release to be crucial in providing more insights about these operating metrics. The company’s performance in this quarter is likely set the tone for the remainder of 2013.

See our full analysis for Charles Schwab

Trading Levels Are Higher, But Not High Enough

Trading activity has shown some improvement in 2013 but is still significantly below its peak levels. During the first two months of this year, the trading volumes have increased marginally and the company reported that its daily average volumes for February were 506,000 shares, up 1% y-o-y. That is the highest level of trading activity since October 2011. However, it is still far below the levels required for a meaningful uptick in trading commission revenues. Accordingly, we expect Schwab’s trading commission revenues to register a low single digit increase in this quarter.

Schwab Lags Behind Peers In Adding Net New Accounts

An area of concern for us regarding Schwab is its seemingly low pace of attracting net new brokerage accounts when compared to competitors. Schwab added just 4,000 brokerage accounts in the fourth quarter of 2012 on a net basis and was far behind E*Trade (NASDAQ:NDAQ) on this metric. E*Trade, which is a much smaller player than Schwab, attracted nearly 10,000 brokerage accounts on a net basis during the same period. ^[1] The lower figure for Schwab could signal that its customer attrition rates are high and we will continue to monitor this theme over the next few quarters.

Schwab has already announced a restructuring of the field sales incentive structure in February, and we expect this action to result in better customer acquisition and retention going forward (discussed in detail below). However, for 1Q12 release we expect the company to continue lagging behind E*Trade in terms of net new accounts.

Asset Gathering Is Strong But The Pace Is Declining

One area that Schwab has performed exceedingly well in the recent years is the rate at which it has managed to gather assets. However, the pace of attracting new assets declined in 2012. The firm attracted nearly $140 billion in net new assets in 2012, thanks to an exceptionally good fourth quarter in which a lot customers brought forward their incomes to save capital gains taxes and invested the money with Schwab. However, that number is still down by about 4% from the year-ago figure of $146 billion.

Since the window of opportunity for saving capital gains has already closed, we believe that the heightened asset gathering activity seen in the fourth quarter of 2012 will not be repeated again. Therefore, we expect the asset gathering pace to decline quarter over quarter. Schwab has already reported net new assets of over $30 billion for the first two months of 2013, and we expect its net new assets for 1Q13 to at least surpass its 1Q12 figures of $39 billion but stay significantly below the 4Q12 figure of $64.4 billion.

Expect A Bump In Compensation Costs

As mentioned earlier, the company has stated that it intends to recalibrate the incentive structures of its field sales in the first quarter of 2013 and compensation expenses are expected to be elevated going forward by around $10 million pre-tax due to this factor.

The increase in compensation costs related to field sales teams may however be a good thing because it is likely to encourage Schwab’s sales teams and result in the company attracting more assets and brokerage accounts over the longer term.

The company has also announced that it has funded its entire annual contribution of approximately $10 million to employee health savings accounts (HSAs) in the first quarter and also expects to record another $10 million as a one-time compensation expense which is related to a previously-announced change in the vesting of equity incentives for retirement-eligible employees.

Thus we are likely to see elevated levels of corporate expenses in the upcoming earnings release. The following quarters’ earnings figures should however benefit from reduced contribution to HSA accounts.

Our current price estimate for the company is at around $15 and will be updated after the earnings release.

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1. E*Trade Press Release, January 24, 2013 [↩]