Although we were early (and wrong), we wrote last fall about two rising interest rate beneficiaries that would likely get some "game" when the interest-rate backdrop failed, and it looked like monetary policy might be on the verge of changing.
The second was the Chicago Mercantile Exchange (CME), which we will talk about in another post.
Charles Schwab had a decent 2nd quarter, '13, which, after excluding the one-time gain in 2nd quarter, 2012, revenues rose 10% and net income was up 11%.
Daily average revenue trades (DARTs) rose 17% and 24% in May and June respectively, the pre-tax margin was 30.8%, versus 25.5% the prior quarter, and core ROE was 10.5%.
Important color to the metrics are that it is clear that as the Great Rotation takes root, and as equities rise and bond prices fall, SCHW should benefit from the rotation as retail investors trade more.
However, because SCHW is waiving their money market management fee, thanks to ZIRP (zero interest rate policy), SCHW's money market fee waived actually rose the last two quarters, as bond fund proceeds that were sold, actually found their way into money markets, rather than the equity market.
Here is a table we put together, that shows historical management fees waived, their "per share" value, and the trailing 4-quarter waiver, which shows the earnings power being masked at Schwab:
SCHW management fees waived
waived ($'s ml's)
fee per share
Source: Internal Spreadsheet
My point in writing the article now, is that the steepening of the yield curve the last three months has actually brought more funds into money markets, which has actually increased the fee waiver (not nearly as bad as the end of 2011 or the start of 2012) but money leaving bond funds has not gone into equity markets apparently, and rather some at least has found its way into higher money market cash balances. (If you think about it this makes sense: for advisors or investors running a standard 60% / 40% asset allocation, bond money might just get re-allocated to cash or money markets, rather than into equity markets, which dramatically changes asset allocation.)
The question remains, how much of the masked earnings power has been discounted in SCHW's stock price appreciation, and how much room is there left to run ?
The current consensus EPS estimate of $0.88 for 2014 is probably the last year where we will see ZIRP (a big assumption), thus if the current fee waivers masks $0.40 - $0.50 in further EPS upside, then "normalized earnings" we can reasonably estimate at $1.30 to $1.40 per share.
At $22 per share, SCHW is trading at 16(x) - 17(x) normalized earnings, for what is more likely to be a 10% EPS grower for the next 10 - 15 years.
Morningstar assigns an intrinsic value of $23 per share to SCHW, while our model is in the high $20's. Depending on equity market appreciation, and the willingness and ability of the retail investor to return to active investing, will determine SCHW's ability to drive growth in excess of high-single digits the next 10 years.
I do believe SCHW is very well positioned for the aging of baby-boomers, and their penchant for saving for retirement, as well as directing a portion of their own retirement investing.
However, the fact is, the 50% appreciation year-to-date probably discounts a lot of SCHW's hidden earnings power.
We think the stock could eventually trade to $30, but there is now a lot of anticipated interest rate news in the stock price.
We remain long all of our original position in SCHW, but are re-thinking the client weighting.