2023-07-19 09:16:51 ET
Summary
- Charles Schwab Corporation has reported strong quarterly results, exceeding expectations on both lines, with shares climbing by 13% on the day of the earnings release.
- While revenues were down year on year, the decline was less pronounced than expected, primarily due to weaker net interest revenue as a result of higher interest expenses.
- Schwab attracted nearly one million new customers during the quarter, with client assets totaling over $8 trillion, suggesting that the company's brand was not significantly impacted by the spring financial sector crash.
Article Thesis
The Charles Schwab Corporation ( SCHW ) has reported strong quarterly results. The company's underlying performance is compelling, and since shares still trade way below the highs from early this year, shares do not look especially expensive -- although they aren't as much of a bargain as they were during the sell-off.
What Happened?
The Charles Schwab Corporation reported its most recent quarterly earnings , for its fiscal second quarter, on Tuesday morning. The headline numbers can be seen in the following screencap:
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Charles Schwab was able to exceed expectations on both lines, which naturally is a strong feat. The market reacted positively to this announcement, as Charles Schwab saw its shares climb by 13% on the day of the earnings release. Now, at $66 per share, Charles Schwab trades almost perfectly in the middle of its 52-week trading range of $45 to $87.
Charles Schwab's Underlying Performance: No Disaster At All
While revenues were down year over year, the decline was less pronounced compared to what analysts and many investors had expected or feared. The revenue decline was primarily driven by weaker net interest revenue, which, in turn, was the result of higher interest expenses. While Schwab's interest income rose substantially versus the previous year's period, being up by $1.4 billion versus the previous year's period, Charles Schwab's interest expenses rose by $1.65 billion over the same time frame, which resulted in a declining net interest income number. That was expected due to the interest rate movements we have seen over the last year, and compared to what some investors feared in the spring, the headwind was not very pronounced -- the sell-off, in retrospect, was way overdone.
Revenues declined due to the aforementioned net interest income headwind, and that did have a negative impact on Charles Schwab's margins. The company's pre-tax profit margin was still extremely strong, at 42%, but not as strong as one year earlier, when the pre-tax profit margin was in the high 40s. As a result, Charles Schwab's net income declined more than the company's revenues, dropping by 25% compared to the previous year's quarter. Of course, a 25% profit decline is far from great in general. But considering that Charles Schwab's shares dropped by around 50% peak-to-trough, and considering that the interest rate headwind will likely not persist forever, the profit decline was not as bad as some had feared: I don't think this was a disaster at all.
Importantly, Charles Schwab showed strong results in the non-interest part of its business. Revenues are generated via net interest income, but Charles Schwab also generates revenues from asset management and administration fees. This business grew by 12% year over year during the most recent quarter, with revenues coming in at $1.2 billion for the quarter. That's less than the top-line contribution from Charles Schwab's net interest income, but with the asset management and administration fees business growing at a compelling pace, this business will become more important over time and should contribute a growing portion of the company's top-line over time. This will make Charles Schwab more resilient versus interest rate movements as time goes by, and the rising importance of this fast-growing business should also have a positive impact on the company-wide growth rate in the future.
The underlying fundamentals bode well for further non-interest revenue growth. Charles Schwab managed to attract a large number of new customers during the quarter, as almost one million new brokerage accounts were opened during the period. This shows that Charles Schwab's offering remains attractive in a time when neo-brokers are receiving a lot of attention: It looks like a large part of the population prefers to go with more traditional brokers such as Charles Schwab, despite the hype that some neo-brokers have received. It seems likely to me that the customers that are doing business with Charles Schwab have more wealth, on average, compared to those that use neo-brokers, which naturally is positive for Schwab when it comes to managing and administering a large sum of money. Client assets totaled a little over $8 trillion during the second quarter, which makes for an average of $235,000 per account. Charles Schwab continued to attract new client money, as core net new assets came in at more than $50 billion for the quarter, suggesting that customers are trusting Charles Schwab and that the troubles in financial markets during the spring and Charles Schwab's crash did not hurt the brand in a meaningful way -- otherwise, we would see clients pulling money out of the company, instead of seeing clients add new money.
With the current stock market rally having a positive impact on client balances, we will likely see client assets rise above the level seen in Q2 during the current quarter. This, in turn, bodes well for the company's administrative and asset management revenues in the current quarter and beyond. While the interest rate macro picture isn't helping Charles Schwab right now, I believe that the longer-term growth story remains intact: Charles Schwab is adding new customers at a compelling pace, these customers are adding money, and rising markets are beneficial for Charles Schwab's asset management revenues on top of that. Wall Street analysts also see considerable growth when it comes to Schwab's expected performance over the coming years:
While revenues for this year are forecasted at a little less than $20 billion, Wall Street analyst consensus estimates imply a revenue growth rate of 12% for next year and of 14% for the year after. Since administrative and asset management revenues have grown at a low-double-digit pace during the most recent quarter, and since net interest income should eventually recover, that seems like a plausible scenario to me. While Schwab will not have a great 2023, relative to the previous year, it looks like the company has a good chance of growing at a compelling pace in the coming years, and Schwab should be able to generate new record revenues in the not-too-distant future. It is worth noting that Charles Schwab has a history of outperforming expectations: In eight of the last twelve quarters, including the most recent one, Schwab's revenues were higher than expected. Current analyst estimates may turn out to be too low, although there is, of course, no guarantee for that.
Charles Schwab: Valuation And Dividend
In the spring, when some regional banks experienced massive problems, Schwab was among the companies experiencing massive selling pressure. Its shares dropped by around 50% from the highs seen in January. This felt overdone at the time, and looking at the most recent results, that holds true. While 2023 will not be a strong year for the company, it will not be a disaster year, either, and SCHW has outperformed expectations for the period while the longer-term growth outlook remains pretty positive.
I covered Charles Schwab in April, when shares traded in the low $50s, calling it a Buy due to overblown selling. Since then, shares have returned 26%, which is a pretty strong result for a three-month time frame. Those that managed to buy Charles Schwab stock at the lows in the mid-$40s have experienced even stronger gains so far.
While this is great news for those that were willing to buy at a time when markets were pessimistic, the sizeable gains experienced so far also mean that the valuation has expanded and that Schwab is not as cheap any longer.
Today, Schwab trades at roughly 20x this year's expected net profits, while the earnings multiple, based on estimates for next year, stands at 16. I don't believe that a 20x earnings multiple is especially expensive for a growth company such as Schwab, especially when we consider that earnings should rise substantially next year. But Schwab isn't a bargain any longer -- at the lows seen earlier this year, SCHW was trading at just 11x next year's earnings, which naturally made for a better deal.
The dividend yield currently stands at 1.5%, which is relatively on par with the broad market. But it is not as high as it was earlier this year when investors were able to lock in a yield on cost of more than 2% in this dividend grower.
Takeaway
Schwab's results were better than feared, and underlying business growth (new accounts, AUM growth, etc.) looks appealing. Interest rate headwinds should subside eventually, and the longer-term growth story remains intact.
From a valuation and yield perspective, I'm less bullish on Charles Schwab compared to a couple of months ago, when shares were outright cheap. But in the long run, investors should do well with Charles Schwab, I believe, which is why I still give the company a Buy rating.
For further details see:
Charles Schwab: Soaring On Strong Earnings