How Sensitive Is Charles Schwab’s Valuation To Its Interest Income?
Charles Schwab (NYSE:SCHW) performed strongly in 2017, with over 15% growth in revenue and more than 30% surge in its stock price over the year. Interest earning assets continued to be the primary growth driver, aided by the Fed’s interest rate hikes.
We estimate that Schwab’s Interest Income accounts for around 60% of its valuation, over 12x the value contribution of its trading commissions. We have created an interactive model that details how changes in asset base and yield on these assets can impact Schwab’s share price. You can modify these assumptions to see their impact on the company’s valuation.
Our price estimate for Charles Schwab’s stock stands at $45, which is below the market price.
Interest Earning Assets
Schwab’s interest earning assets have been growing significantly in the last few years, reaching over $217 billion in 2017, having almost doubled since 2012. We currently forecast these assets to grow steadily through the end of the Trefis forecast period, eventually approaching $416 billion. However, should the growth be slower than expected – due to intense competition and any need to deleverage the balance sheet – and these assets remain around $337 billion in the long run, keeping the interest rate same as the base case, there would be a potential downside of 10% to our price estimate for the company’s stock. Alternatively, if the asset base reaches $485 billion (Scenario 2), keeping the interest rate same as the base case, it could boost the valuation by 10%.
Net Interest Yield
Schwab’s structure ties its net interest yield to market interest rates. Under the impact of the recession, the interest yield declined over the years to as low as 1.6% in 2015. The yield picked up pace with the Fed’s interest rate hikes in 2015, 2016 and 2017 due to improvement in the U.S. economy, and reached nearly 2% in 2017. We forecast this yield to reach around 3.37% by the end of our forecast period as we expect the U.S. non-revolving consumer credit to see growth going forward driven by improving macroeconomic conditions. However, if the interest rate hikes take longer than expected, and the net yield only rises to about 2.7% during the same timeframe (Scenario 3), keeping the assets the same as the base case, there would be a downside of 10% to our price estimate. Alternatively, if the net yield crosses 3.7% (Scenario 4), keeping the assets in line with the base case, it could boost the company’s valuation by 5%.
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