2023-06-19 08:02:36 ET
Summary
- My views on Charles Schwab have been quite balanced, and my last 'neutral/hold' rating has worked out. But now I am changing my stance based on new data.
- On the positive side, cash sorting trends are improving.
- But growth in core net new assets is unusually low.
- Asset management business is punching below its weight.
- The consensus view is set for disappointment.
A Change in Stance After A Thesis Review
I believe the fight between the bulls and the bears on Charles Schwab ( SCHW ) ( SCHW.PD ) ( SCHW.PJ ) has been quite balanced over the last few months as some key performance metrics have shown improvement and some others have kept investors cautious. I, too, have been swaying on the fence, as I had revised my ' buy ' rating to a 'neutral/hold' in my last update .
Looking at the performance, I would say the neutral stance has been a decision that has worked out well since the stock has underperformed the S&P 500 ( SPY ) ( SPX ) by 3.59% since my last publication, although it still generated positive returns:
Performance of my last rating on Charles Schwab (Seeking Alpha, Charles Schwab: No Fat Pitch Here)
Now, after reviewing the data for May, I am compelled to change my view again towards a 'sell' as I believe the bears have more points in their favor overall.
Cash sorting trends are improving
Charles Schwab Net New Purchased Money Market Fund Flows (Company Filings, Author's Analysis)
Firstly, a plus point for the bull case; cash sorting trends improved as net new purchased money market fund flows (which represents flows away from higher interest-earning bank deposits into the lower interest-earning money market funds) saw a decrease from the previously high levels of more than $25 billion per month. April saw a sharper drop than usual due to clients having a greater need for cash due to tax season. Hence, I view May as a more normalized measure of cash sorting trends.
CFO Peter Crawford noted that the pace of these improvements in cash sorting continued through June . Based on this, I have estimated the cash movement metric to be $8 billion on June 14. If this run-rate is continued, I anticipate June to close out at $16-17 billion.
Overall, the developments in this key metric are a clear positive for the stock as it helps improves the interest yield.
Growth in core net new assets is unusually low
Charles Schwab Core Net Assets (Company's Press Releases, Author's Analysis)
Core net new assets (which exclude the lower fee mutual fund clearing and certificate of deposit flows) was unusually low at only $21 billion in May 2023. This is more than $10 billion lower than the lower range of the typical month since February 2022 (excluding April, which sees a seasonal drop due to withdrawals related to tax season).
I am a little surprised because May was a bullish month for the US stock markets. So far, June has been even more bullish as the S&P500 has climbed up 5.52% on a total shareholder return basis. I look forward to hopefully hearing more details in management's Q2 FY23 commentary.
Asset management business is punching below its weight
22% of Charles Schwab's revenues comes from its asset management business as of Q1 FY23 . A think a key indicator of the performance in this business is the net new active brokerage accounts, excluding involuntary closures initiated by Charles Schwab (to remove inactive accounts):
Net New Active Brokerage Accounts Excluding Company Initiated Closures (Company's Press Releases, Author's Analysis)
In May, this figure came in at half the typical rate in the months prior, even when the markets went up. I think it may be likely that this is correlated with the slowdown in core net new assets growth. I believe the slower net new accounts trend has continued for at least the first fortnight of June 2023. This is because on June 12, 2023, the CFO cited "softer trading activity" in his monthly commentary. If the slower activity here was restricted to May 2023, I suspect the CFO would have commented on a rebound in June 2023.
The consensus view is set for disappointment
Following May 2023's key metrics data, the CFO gave Q2 FY23 guidance that disappointed consensus expectations. Wall St expected $5 billion in revenues for Q2 FY23, implying a YoY revenue decline of 1.8%. However, management is guiding for a steeper 10-11% YoY decline due to lower net interest margins (NIMs).
Despite this, the current consensus expectation for Q2 FY23 revenues stands at $4.7 billion, which corresponds to a smaller 7.8% YoY decline. In other words, the market is pricing in more optimism than what management is indicating. This may be a key reason for the muted negative reaction by the market in response to the revised downward guidance.
But is this optimism warranted? I doubt it:
Revenue Surprise vs Consensus (Capital IQ, Author's Analysis)
The trend of frequent revenue misses vs consensus expectations clearly shows Wall St's tendency to overestimate Charles Schwab's performance over the past 7 quarters. For this reason, I think the chances of further negative surprises against the implied optimistic expectations is elevated, leading to downside risk for the stock.
Takeaway
The central issue for Charles Schwab in recent months has been the cash sorting headwinds wherein customers were moving funds from low interest instruments to high interest ones, thus dampening Charles Schwab's interest revenues (which makes up 78% of revenues). The bulls can rejoice as the May 2023 data shows that these headwinds are subsiding.
However, last month's key metrics release highlight new issues in the company such as tepid growth in core net new assets, a disappointing print in net new active brokerage accounts and indications of "softer trading activity" that is probably continuing on into June 2023, despite strong bullish moves by the equity markets.
Management has signaled a 10-11% YoY decline in Q2 FY23 revenues, however the market does not seem to believe this as consensus is only building in a 7.8% YoY decline. The recent trend of revenue misses vs consensus expectations suggests to me that Wall St is likely to be wrong on their expectation. I believe this increases the downside risk for the stock as we get closer toward the Q2 FY23 earnings release.
For these reasons, I am revising my previous 'neutral/hold' rating down to a 'sell'. I anticipate negative alpha ahead vs the S&P 500 ((SPY)) ((SPX)). Hence, I would rather be invested in the market via an ETF such as the Vanguard S&P 500 ETF ( VOO ).
For further details see:
The Market Is Too Optimistic On Charles Schwab