2023-05-21 11:43:16 ET
Summary
- IBKR has competitive advantages that set it apart from the competition.
- Low costs, a wide range of services, and good margins are strong arguments for IBKR.
- And the stock is pricing in relatively low EPS growth, despite much higher growth rates in the past. That makes it an attractive opportunity.
Thesis
Interactive Brokers (IBKR) could be an interesting opportunity for long-term holders, as it has cost and technology advantages over its competitors that should enable it to defend and even grow its earnings in the future. In addition, the shares are currently attractively valued on the back of future growth prospects.
Analysis
As you can see from the 5-year CAGR for customer accounts and customer equity, IBKR is growing quite rapidly. And they even increased the number of customer accounts to 2.2 million in Q1 2023 , a further 21% improvement on the same quarter last year.
But their biggest and most important improvement in the first quarter was due to the increased yields, as shown in the chart above. This led to a 126% improvement in net interest income as IBKR benefited very strongly from the FED rate hikes. Commission income, on the other hand, increased only slightly from $349 million to $357 million.
This is one of IBKR's competitive advantages, as it can offer its clients better interest rates and margins than most of its competitors. The short duration of their invested funds allows them to pass on interest rate increases quickly to their clients.
Their interest rates on margin loans are sometimes half those of their competitors because they have better automated processes that help them to keep costs down. And their interest rates on cash are also competitive, but the advantage is not as great as with margin lending. There are a few competitors in Europe offering the same rate, but most of them have limited their offer to $50,000 or $100,000. IBKR, on the other hand, does not have such a low cap, but only offers it if you have more than $10,000, while the competition also offers the rate for balances below $10,000.
In their most recent earnings call , IBKR stated that each 25 basis point increase in US interest rates is expected to result in approximately $50 million of additional net interest income, and that international increases will be approximately $26 million for 25 basis point increases.
The majority of accounts are international, with Asia Pacific accounting for 39%, Europe 29% and North America 32%. However, the majority of commissions are earned in North America with 51% and with only 19% in Europe and 30% in Asia.
And here is another competitive advantage for IBKR, as they really do help international clients to gain low-cost access to the world's stock exchanges, where many European competitors are currently lagging. For me personally, IBKR is much cheaper for small and mid-caps than the traditional brokers in Europe, and the new players, who are like Robinhood (HOOD) in the US, have a limited selection of stocks at the moment, but they are working on being able to offer more.
To show the strong business improvement over the last 10 years, we can see that they have drastically improved their net profit margins while growing as strongly as they have, and this really speaks to their outstanding technology, which helps give customers the best prices through IB smart routing and also saves costs for IBKR. However, on a more critical note, their 5Y average annual ROIC is relatively unimpressive at just ~6%.
But their balance sheet is rock solid, with $3.2 billion in cash and no debt, and 75% insider ownership, perfectly aligned with shareholder interests.
However, the number of shares outstanding is growing relatively fast, but this is also due to their 'refer a friend' program, which gives you $1 in IBKR shares for every $100 you deposit, up to a maximum of $1,000 in shares. Therefore, expect the number of shares outstanding to continue to grow in the future, as more new customers lead to more shares.
Growth Opportunities
Asia and Europe offer growth opportunities as more people in these regions start to invest in equities, and the hedge fund clients also offer growth opportunities as IBKR is currently ranked #6 but is likely to be ranked #4 later this year as Credit Suisse is gone and the chances of surpassing Bank of America are good as Thomas Peterffy pointed out in the last earnings call based on Preqin data.
However, it should be noted that most of IBKR's hedge fund clients are small, with an average fund size of only $8 million, and the larger hedge funds have IBKR as a second or third option, using other brokers as their first option.
But overall, IBKR has something of a competitive advantage due to its very good margin lending rates, combined with its low costs and industry-leading profit margins, as well as its API, which allows quant firms to access its software.
Reverse DCF
If we take the TTM diluted EPS of $4.43 and see how much growth is priced in to achieve a 10% CAGR, we see that it is only 9%. In contrast, the historical 10Y EPS CAGR was 19.28% . This could lead us to believe that the shares are undervalued, and the P/E GAAP of 17 compared to the 5-year P/E of 24.78 also supports this view. The upside to the 5-year average is around 40%.
However, it is important to note that the tailwind from FED rate hikes has been positive for earnings and future rate cuts could be negative for earnings.
Risks
Robin Hood and its alternatives with their PFOF could affect future earnings and I do not think there is much chance of these being banned in the US as Citadel probably has good lobbying. But IBKR has tried to make a run at it with IBKR Lite, but it is only a very small percentage of revenue.
Conclusion
I think IBKR is an interesting long-term play with a competitive advantage that is currently attractively priced. Their strong balance sheet should also act as a safety net, and they should have growth opportunities in Europe and Asia. The main points of criticism, however, are low ROIC and sometimes below-average customer service .
For further details see:
Interactive Brokers Group: This Is A Good Opportunity To Participate In Growth
