2023-04-18 20:53:56 ET
Summary
- Charles Schwab just reported mixed, but largely positive results for the first quarter of its 2023 fiscal year.
- While the company did show some minor weak points, the picture as a whole looks great, with its core operations continuing to grow.
- Growth in client assets and robust earnings more than offset concerns about the future and will likely mean great results for investors in the long run.
In my view, some of the best results come from buying stock in some of the most misunderstood companies on the market. And few companies right now are as misunderstood as The Charles Schwab Corporation ( SCHW ). Driven in large part by fears associated with the banking sector, shares of the company have taken quite a tumble compared to where they were at their 52-week high mark. The stock has shown some signs of recovery. But even with its price rising, it's still down 39.1% from its high point earlier this year. Interestingly, this is true even after the company reported some rather interesting, and largely promising, data points for the first quarter of its 2023 fiscal year. Management made the decision to suspend their share buyback program. The firm also did see a continued decline in its deposits. But outside of this, the data was incredibly strong, and it should serve as a catalyst to push the stock up even further moving forward.
Mixed headline news
As with any company that announces financial results, the first thing that investors seem to focus on is the headline news. Given that this is an area covered elsewhere by others, I won't dwell too much on it. But it does warrant some acknowledgment. Total revenue for the first quarter of the 2023 fiscal year came in at $5.12 billion. Although this missed analysts' expectations by $10 million, the size of that miss is so small that I would argue it's essentially irrelevant. This sales figure also translates to a 9.5% increase over the $4.67 billion the company reported the same time last year.
Author - SEC EDGAR Data
There were multiple moving parts that contributed to this rise. But the most significant was undoubtedly the net interest revenue that the company generated. This came in during the quarter at $2.77 billion, translating to an increase of 26.9% year over year. Given this significant rise over the $2.18 billion reported in the first quarter of 2022, you might think that the increase was driven by higher interest-earning assets on the company's books. But this was actually not the case. Total interest-earning assets ended the first quarter of this year at $504.60 billion. That was down from the $632.38 billion reported only one year earlier.
With the exception of held-to-maturity securities and bank loans, all interest-earning asset categories for the company declined. This, unfortunately, can be chalked up trade decline in bank deposits and payables to brokerage clients. Management attributed the bank deposit shrinkage, which totaled about 11% sequentially and was 30% below what it was the same time last year, to the decision by clients to ‘realign’ how their capital is allocated across the company’s suite of offerings. Despite this pain, the company benefited immensely from a rise in the effective yield it gets, net of how much it has to pay for access to capital. This number grew from 1.38% per year in the first quarter of 2022 to 2.19% the same time this year.
Charles Schwab
This is positive in and of itself. But management did warn that the high cost of funding would likely lead to revenue falling in the second quarter of this year compared to the second quarter of last year, with that decline likely in the mid to upper single-digit range. One example of the higher cost of capital can be seen by looking at the borrowings the company has from the Federal Home Loan Bank program. The firm had no exposure to that in the first quarter of last year. But this year, as of the end of the first quarter, it had $24.46 billion in borrowings under that. That comes at a rather lofty 5.05% interest per annum.
On the bottom line, analysts were forecasting earnings per share of $0.81. The company reported earnings per share that were slightly higher at $0.83. Not only did the company beat expectations, it also reported earnings that were far higher than the $0.67 per share that it achieved in the first quarter of 2022. This translated to net profits for the company of $1.53 billion, which was up from the $1.28 billion reported one year earlier. The high-margin nature of net interest revenue certainly aided on this front. But the company also saw the category of ‘preferred stock dividends and other’ decline from $124 million to $70 million. And on top of all of that, the company noted that it continues to cut costs significantly. When the company acquired TD Ameritrade, it stated that it was targeting between $1.8 billion and $2 billion in run rate synergies stemming from the deal. Management indicated that they are making really solid progress on this, with the final $500 million to $600 million in annual savings likely to be captured by 2024 sometime.
Some great developments
Author - SEC EDGAR Data
Because of some of the issues that I mentioned associated with higher funding costs, as well as greater uncertainty in the regulatory and economic environment, management has decided to pause its share buyback program. This sounds like a prudent move to be honest, even though it's disappointing to see the company curtail its plans at a time when the stock is so low. But there are other reasons to be very optimistic. For starters, overall client assets reported by the company increased even though the company reported weakness in some areas. Overall client assets ended the quarter at $7.58 trillion. This is still down from the $7.86 trillion reported one year earlier. But it represents a meaningful improvement over the $7.05 trillion the company had only one quarter earlier.
Author - SEC EDGAR Data
Leading into the firm's earnings release, the investment community knew that there was some rise occurring when it came to the company's assets. But it was unclear exactly what the end result would be. You see, from December of last year until January, total assets spiked from the $7.05 trillion I already mentioned up to $7.48 trillion. That number then dropped to $7.38 trillion in February. This was all publicly known prior to the earnings release. But with the final reading for March, that means that the company added $199.8 billion in the month of March alone. This is really surprising given the concerns of contagion spreading across the banking sector.
Author - SEC EDGAR Data
A big component to the client asset figure was the amount of money made or lost because of asset price fluctuations. If instead we focus only on net new assets, which would be the total assets that flooded in from clients, minus those that left, you would have seen an increase in the month of March of $72.9 billion. This was the highest inflow in at least one year. By comparison, in February, the inflow on a net basis was $41.7 billion. This was aided in large part by a surge in new brokerage accounts totaling 378,000. This is the highest number reported by the company until you go back as far as April of last year. Actual active brokerage accounts for the company ended at 34.12 million. This was 110 million above what the company reported Only one month earlier and stacked up nicely against the 33.76 million that the company had at the end of the final quarter last year. This shows robust confidence in the company's potential and existing user base.
Author - SEC EDGAR Data
Takeaway
Right now, I can understand investors being a bit concerned about what the future holds. We did experience a miniature banking crisis earlier this year and anything related to that sector was bound to come under scrutiny. But when you really dig into the numbers here, you see that Charles Schwab is doing quite well for itself. Yes, the company is dealing with higher funding costs. But outside of that, it's showing continued and attractive growth in its user base. Given these factors, I cannot help but rate the business a ‘strong buy’ to reflect my view that it should outperform the broader market rather substantially moving forward.
For further details see:
Charles Schwab: The Bearish Argument Falls Apart