The recent announcement by the Fed that it would be extending low interested rates until 2014 puts both Charles Schwab (SCHW) and TD Ameritrade (AMTD) in a precarious position. The Street currently rates the former a "hold" and the latter a weak "buy". Based on my multiples analysis and DCF model, I agree with this sentiment.
From a multiples perspective TD Ameritrade is the cheaper of the two. It trades at a respective 14.3x and 12.4x past and forward earnings with a dividend yield of 1.5%. Charles Schwab trades at a respective 16.4x and 13.9x past and forward earnings with a dividend yield of 2.1%. Both firms are 30% more volatile than the broader market.
At the first quarter earnings call, TD Ameritrade's CEO, Fred Tomczyk, noted the business environment:
"When we met last quarter, we talked about the high degree of uncertainty in the markets and the fear of a double-dip recession in the U.S. Well, one quarter later, there are signs of the U.S. economy improving. We seem to have avoided a double-dip recession, but growth is at a pace that continues to suggest this will be a long slow recovery.
At the same time, the cloud of uncertainty over Europe remains. It is clearly impacting the markets and as a result investor sentiment. And the Fed continues to intervene in the markets which when combined with the European debt crisis has flattened the yield curve considerably over the last six months.
I think we all need to recognize that none of us knows how this is all going to play out. In this type of environment, I think it's important to focus on what you can control, keep a healthy balance sheet, protect yourself from the downside and be ready to take up advantage of opportunities that may come along".
Then came the Fed's announcement and the report that US GDP grew by only 2.8% for the fourth quarter. Ultimately, this will have a very meaningful impact on yield-driven sales for both TD Ameritrade and Charles Schwab, hence the major estimates revisions. With that said, TD Ameritrade has a strong brand and a market that is uniquely focused on taking long-term positions. First quarter results featured earnings growth of 4.8% y-o-y and a 7.1% sequential decline. With limited control over the economic and political headwinds, management is likely to focus more on mitigating its cost base. The firm is targeting a capital allocation policy that returns upwards of 60% of earnings back to shareholders.
Consensus estimates for TD Ameritrade's EPs forecast that it will hold flat in 2011, grow by 17.1% to $1.30 in 2012, and then by 20.8% more in 2013. Of the 19 revisions to estimates, all have gone down for a net change of -4.2%. Modeling a CAGR of 12.3% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $19.94, implying 23.8% upside.
Charles Schwab similarly faced negative earnings revisions with all 178 down for a net change of -7.3%. Fourth quarter EPS of $0.13 was roughly in-line with expectations. The conclusion of the year featured a notable rise in NNAs to $10.5B in December, but revenues still declined by 6% sequentially. MBS prepayment was faster than expected and non-comp costs climbed 5% higher sequentially. Charles Schwab netted 42K more brokerage accounts during the quarter.
Consensus estimates for Charles Schwab's EPS forecast that it will decline by 2.9% to $0.68 in 2012 and then grow by 22.1% and 30.1% in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $0.80, the rough intrinsic value of the stock is $12.80, implying 9.9% upside.