FNNTF - flatexDEGIRO: It Could Get Worse Before It Gets Better

2023-04-06 07:41:42 ET

Summary

• Customer transactions are the most important revenue driver for the online broker.
• Monthly transaction numbers for Q1 show that the company risks having again lower transactions this year than in the previous year, after the significant setback in 2022.
• As the margin loan book and customer deposits are flat (or slightly lower), increased interest rates are the only positive revenue driver.
• The increased interest income will probably not be able to compensate for the reduced commission income.
• There is also a risk of a deposit outflow due to increased competition for deposits in core markets.

(Note: all amounts in the article are in EUR. At the current exchange rate this is almost equivalent to USD.)

Investment Thesis

In my two previous Seeking Alpha articles ( flatexDEGIRO: Don't Buy The Long-Term Growth Story and flatexDEGIRO: 2026 Growth Vision Is Unlikely To Happen) on flatexDEGIRO ( FNNTF ) I wrote that the company’s ambitious growth vision is unlikely to become reality.

I think this is a settled question now, although the company has not publicly acknowledged it yet. flatexDEGIRO achieved exceptional growth rates during the pandemic years 2020 and 2021, but since last year it is clearly falling short. It would require growth rates to continue for several years on that 2020/2021 level for the vision for 2026 to become reality. This is clearly not happening and on some metrics – especially executed transactions – there is even a negative growth, to use this euphemism.

Still, with a P/E ratio of 9.3 based on (adjusted) 2022 earnings per share of EUR 0.72, the online broker looks cheap - especially compared to its historic valuation. It was also encouraging to see insiders buying while shares were falling over the last months.

Since the beginning of this year, flatexDEGIRO has been publishing monthly KPIs, and I was curious to see how the company has been doing. Unfortunately, based on those numbers it looks to me like 2023 revenue and earnings could be around where they were in 2022 – maybe a little less, maybe a little more. So, maybe shares are not that cheap and priced fairly where they are now – if you see flatexDEGIRO not as a fast-growing Fintech, but a specialty financial services company without a large economic moat?

Performance on KPIs in Q1 2023

Since the beginning of this year, flatexDEGIRO has been publishing quite detailed monthly performance numbers on its KPIs. Management deserves credit for this shareholder friendly practice. The published information is very useful as we do not have to wait for the quarterly numbers to understand the trajectory of the business.

The key numbers I am usually looking into are customer accounts and executed customer transactions to understand where the commission income is going. To understand the trajectory of interest income I look at customer deposits and the size of the margin loan book.

Customer Accounts and Transactions

Customer accounts grew by 100,000 to 2.5mn. The YoY growth rate was 13%, which is not bad as it shows a higher growth rate than in previous quarters - but still below where growth was in 2020 and 2021.

But the number of customer transactions was only 16.3mn, around 1/4 lower than in Q1 of last year. The average number of transactions per quarter in 2022 was 16.75mn, so transaction numbers need to pick up over the next three quarters, or they will fall below 2022. Lower transaction numbers in two consecutive years do not go well with a growth story.

Transactions are the most important driver of revenue for flatexDEGIRO. The online broker assumes commission income of 265mn and interest income of 100mn for 2023. A lower number of transactions executed in 2023 almost certainly means lower revenue and profit.

Interest Income

Due to the increased rate environment, interest income is a rare bright spot for the online broker in 2023. In 2022 the effect of higher interest rates was really only visible in Q4, so YoY we should see an increase. Due to the EU banking license (in Germany), flatexDEGIRO can put uninvested costumer deposits to use and create additional interest income.

Of the 100mn interest income that are forecasted for 2023, 36mn should come from margin loans. The margin here is assumed to be 4%, on a volume of 900mn. In Q1 the volume was 900mn in every month from January to March. So this is positive as it meets the guidance.

62.5mn should come from the Treasury portfolio, with a lower margin of 2.5% and a volume of 2.5bn.

Together this comes to uninvested customer deposits of 3.4bn. The online broker achieved exactly this number in January and February but fell slightly below it in March. In March uninvested customer deposits where only 3.3bn. The difference could be because customers have invested more into their portfolios, or the money was flowing out, which would obviously be bad.

Unfortunately an outflow would make sense, as there is currently significant competition for customer deposits across Europe - from banks, but also other brokers. flatexDEGIRO pays no interest on customer deposits, which used to be in line with competitors. But this has changed. In January 2023 Trade Republic, a significant competitor to flatexDEGIRO across Europe, but especially in Germany, announced a departure from the long-standing practice that direct brokers do not pay interest on deposits. Trade Republic is now paying 2% on all deposits. On April 4, ING Diba (the German direct banking subsidiary of ING Group) announced that they will be paying 3% on deposits for new and existing customers. And those are just two of many examples.

It seems to me that sooner or later flatexDEGIRO will have to at least match this practice to some degree and pay some interest for customer deposits, or it needs to deal with deposit outflows. The outcome should be a negative one for the online broker in both cases - either the margin reduces or the base deposit volume goes down. The effect is the same: less interest income.

Conclusion

Since beginning of the year flatexDEGIRO has been publishing monthly KPIs, enabling investors to better monitor the progress of the online broker outside of the quarterly reporting.

Although the January-March numbers are mostly in line with previous management guidance, there are some warning signs that we could see a further deterioration of revenue and earnings. At least a return to previous growth rates is not visible (yet).

My recommendation is still to stay on the side-lines here.

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