Charles Schwab Surges on Earnings Report

| About: The Charles (SCHW)

San Francisco retail brokerage and fund manager Charles Schwab (NYSE:SCHW) was one of just a few gainers on the NYSE on Friday, soaring more than 6% as broad market indexes slumped more than 2%. The reason for the rise was the company narrowly topped analysts’ expectations, and they also forecast better times ahead as well. Revenue came in at $1.08 billion; flat compared to last year but better than Wall Street had estimated at $1.06 billion. Furthermore, revenue rebounded sharply from the first quarter growing about 10%, reflecting improved interest margin and raised asset management fees. Net income came in at $205 million or 17 cents per share, which topped average analyst estimates by 2 cents. Schwab ended the quarter with client assets of $1.36 trillion up 11%, as both brokerage and banking accounts experienced growth.

This quarter may mark an important turning point for the company that has struggled under a near zero interest rate environment for more than a year. In the last quarter short term rates stabilized at a slightly higher levelSCHW and the net interest margin (the difference between the interest they pay to depositors and that which they are paid for them) widened. Revenue from interest earned surged to $382 million about a third of overall revenue and 26% better than last year. Should the economy continue to improve Schwab would likely benefit doubly from a continuation of the interest margin trends as well as further growth in size of client assets. Management sounded optimistic about the second half of the year, and their ability to grow assets, revenue and earnings going forward.

Schwab also reported gains in trading activity centered around the “flash crash” episode in early May, yet revenues from trading remained a sore spot in the results falling 14 percent for the quarter. This may perhaps foretell an exodus from equities as fund flows and other data suggest started in the later part of the second quarter. Indeed, net flows into Schwab’s funds were down $14 billion. There is no doubt that the company has weathered a difficult period and should benefit from sustained growth in its asset base. At Ockham, we are reaffirming our Fairly Valued rating on SCHW even as they may be turning a quarter but challenges remain. Short term interest rates did give the company some relief in the quarter, but with renewed fears of double dip and deflation starting to rear its ugly head, interest rates may remain low for an extended period. The stock is trading within its historically normal ranges of both price-to-sales and price-to-cash earnings, so there is nothing particularly intriguing from a historical valuation standpoint.

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