2023-04-17 18:20:54 ET
Summary
- Charles Schwab beat estimates for Q1-2023.
- We tell you why you should not get excited over that.
- Instead, focus on three other things that hint at where this will likely head next.
Beating estimates is generally an easy game. You under promise and then analysts help you out by lowering the bar just enough. Of course the odd company misses these layups, but most of the time, the "beat" is the norm. The Charles Schwab Corporation ( SCHW ) was not an outlier this quarter and the bottom line looked healthy relative to analyst estimates. We tell you why the bears are not exactly losing sleep on these numbers.
The Numbers
Net revenues grew 10% and adjusted earnings per share zoomed to 93 cents, up 21% year over year.
SCHW Q1-2023 Press Release
While those looked great, keep in mind that no one was even remotely predicting a collapse in these numbers. Instead the focus was on the rate of change and here, we are referring to the quarter over quarter numbers. From Q4-2022, net revenues dropped by $381 million or close to 7%.
SCHW Q4-2022 Press Release
Adjusted earnings dropped by about 13%. The drop in net revenues was primarily from net interest revenues which declined by $258 million, quarter over quarter. The other big drop came from bank deposit account fees. These were at $350 million in Q4-2022.
SCHW Q4-2022 Press Release
This quarter came in almost $200 million lower.
SCHW Q1-2023 Press Release
About half of this drop was from a transition, but the rest of the drop was likely related to investors switching to different types of accounts where they can earn interest.
Additionally, asset management and administration fees increased slightly, while trading revenue declined, and bank deposit account revenue was down due in part to a $97 million one-time breakage fee relating to ending our arrangements with certain third-party banks ahead of the initial Ameritrade client transition group.”
Source: SCHW Q1-2023 Press Release
Now, don't get us wrong. The overall numbers were ok and Charles Schwab continues to attract investment assets. The vast majority of deposits also remain within the FDIC umbrella.
So bank run threats remain incredibly low. There are still three major concerns for the bulls and we don't think you can go "hand over fist" here.
1) Earnings Estimates Are Contracting Sharply
The biggest directional mover for stocks is always the change in earnings estimates. You can argue that something is "cheap" until you are blue in the face, but 95% of stocks will tend to move lower when their estimates are cut. For Charles Schwab, this is a big headwind as earnings will likely contract on a year over year basis for the next three quarters of this fiscal.
What is more important is that analysts are really taking an axe to these numbers.
Remember our point at the beginning of the article. We believe analysts will set up Charles Schwab to ultimately beat these estimates, so they need to get them low enough. This will pressure the stock as soon as the oversold rally is done.
2) The Company Guided Down Significantly
Perhaps this was missed in the euphoria of the beat, or perhaps it was a "cover on the news" situation. But the company did guide down on net revenues and total revenues will decline about 6-9% year over year.
Our point here is that despite all of these estimates being cut, it appears analysts are once again too optimistic. We are so far factoring a less than 2% decline year over year, whereas we might actually see a 7%-8% decline.
Both revenues and earnings need to be revised lower again just to get to where the company guided. Further, we think the company is underestimating how quickly net interest margin will collapse as the Federal Reserve hikes once again. Their source of zero or almost zero, cost funds are about to disappear. So look for revenues under $4.7 billion on Q2-2023. Look for earnings under 75 cents a share in Q2-2023 and Q3-2023.
3) The Buyback Pause Is Necessary, But Will Empower The Bears
The cheapest source of funds for Charles Schwab are retained earnings. Pausing the buyback allows tier 1 and other regulatory ratios to improve and lowers perception of risk. That in turn should allow lower borrowing from high cost sources. That's all good but the timing could not be worse. The company which bought back shares at almost twice the prices we see today, just paused the buyback. So bears will delight in this news and rightly so.
Verdict
Two weeks back we told you the stock was not cheap for a multitude of reasons. Here we are with the new lowered guidance and if you take our calculations at face value, the stock has become really expensive. At 75 cents a quarter or $3.00 in annual earnings, the stock is trading at a 17X multiple. Bulls will argue that that number is cheap relative to its history.
That is true, except for the fact that the zero commissions model was introduced in late 2019 and the period prior to that was not so dependent on spread income. We will add that the 30X multiples were during a time when risk free rates were close to zero percent. As recent events have shown, there are some risks present that investors had previously ignored. A 17X multiple on the eve of a recession does not sound like a bargain entry price for a broker. Since we don't think there are existential risks, we don't think this is a good short candidate either. We rate the shares as neutral/hold for now.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Charles Schwab: Results Should Encourage Bears