Schwab Earnings Preview: Rising Money Market Rates And Equity Values The Right Combination

| About: The Charles (SCHW)

Summary

Forward EPS and revenue estimates have risen sharply, usually a good sign.

Schwab's 4-year average "expected" EPS and revenue growth rates are 34% and 15% respectively.

Schwab is trading at 32(x) and 25(x) '16 and '17's current estimate for expected 34% and 26% growth.

Charles Schwab (NYSE:SCHW), the iconic "Chuck" of the former discount-brokerage business, reports their Q4 '16 earnings before the opening bell on Wednesday, January 18th, 2017 and according to Briefing.com, Street consensus is expecting $0.35 on $1.99 billion in revenue for expected year-over-year growth of 46% and 18% respectively - a pretty decent growth for a well-known Financial name.

Readers should remember that it was the 4th quarter of 2015 where credit spreads widened, commodity prices collapsed, and the S&P 500 peaked in late November '15, thus the point being Schwab is now lapping a quarter where EPS growth was flat in q4 '15 and revenue grew just 9%, still not bad for a tough quarter.

EPS and revenue estimates have increased nicely since the Sept. '16 quarterly release. (See table below).

Schwab has been a major holding of clients for many years, within most accounts the top Financial holding in a sector that has had an overweight position in client accounts since 2009, 2010. (Yes far too early...) Mutual fund and other "asset gathering" institutions like Schwab have been tortured since ZIRP (zero interest rate policy) in 2008, since lucrative money market management fees had to be waived as I wrote about here, here and here. (The last shorter article was here in early 2016, after the commodity meltdown and the spread widening and shortly before Schwab's investor day, simply because I thought readers would be weary of reading the same old basis for the position.)

So what has changed with Schwab?

The biggest change with Schwab is that the FOMC is poised to continue to raise the fed funds rate, which will result in not just Schwab but all mutual fund and asset gathering institutions to start to be able to begin charging management fees on money market holding once again. At the zenith of the money market waiver, Schwab was waiving between $0.40 and $0.50 per share per year to shareholders.

In other words, Schwab and shareholders were "eating" that fee.

This is no longer the case, as the following table shows:

Ttl Fee

waived ($ml's)

Per Share

waiver

TTM

waiver

Y/y gro

Total

M-Mkt $'s bl's

9/16 $41 $0.031 $0.26 -52% $162 bl
6/16 $55 $0.041 $0.35 -36% $161 bl
3/16 $97 $0.073 $0.44 -23% $166 bl
12/15 $153 $0.115 $0.51 -11% $161 bl
9/15 $166 $0.125 $0.53 -5% $149 bl
9/14 qtr $190 $0.144 $0.56 +15%

Source: Schwab earnings reports and 10-Q's

The two columns that should be of interest to readers are the "TTM" or trailing-twelve-month fee waiver and its y/y growth as it shrank.

That means EPS was being increased as fewer m-mkt management fees were waived.

What was fascinating - and I didn't understand the logistics or mechanics - was that Schwab, possibly fearing another 4 years of ZIRP in the next Administration, restructured their balance sheet without impacting the credit rating from either Moody's or S&P, and actually started paying a small money market interest rate before the first rate increase in December '15, and which started to bring the money market fee waiver down over time.

But the point is that, now that the FOMC is engaged and in the game, with a pro-economic growth Administration, investors of all classes might start seeing interest paid on cash balances for the first time in 8-9 years, and a small fee being taken by Schwab on their money fund balances.

What other catalysts are on Schwab's radar screen?

1.) The individual investor has been out of the market for years, as evidenced by the large amount of cash that investors are sitting on - tax reform and pro-economic growth agenda could help bring those investors back into the market. Hopefully not like the late 1990's, but there should be some renewed interest as this newer secular bull market gets legs.

2.) Dividend and share repurchases: as money market rates improve and Schwab sees not only no fee waivers, but additional fee revenue, Schwab might not have to go so long between dividend increases and share repurchases. Schwab raised their dividend to a quarterly rate of $0.07 a share in June '16, the first penny increase since mid-2009. Also, Schwab does have some share repurchase authorization left - and has had so for many years but not used it - and now may be the right markets to do so.

Schwab never lost their Single-A investment grade credit rating during the nasty decade that was the 2000's, both the large-cap growth and tech collapse, which cratered trading volumes, and then 2008. It is a conservative company that knows how to manage the balance sheet. With no proprietary trading, Schwab doesn't have that revenue volatility, so with (perhaps) less regulation via relaxation of Dodd-Frank, SIFI, and better capital markets, Schwab might be able to start returning capital, rather than the slow shareholder dilution it's been engaged in over the last few years.

Technical analysis:

Here is a monthly chart of Schwab going back to the late 1980's: the spike you see around the Tech and large-cap-growth craze of the late 1990's was PE expansion driven by trading volume.

The all-time highs for the stock were $51.69 in May of 1999, and then $44.78 in April of 2000, and it was followed by a decade of consolidation and "normal" growth, with a horrific bear market thrown in in October 2008.

I do think - depending on some of the fiscal policy that might be seen in 2017 - that Schwab will eventually make a run at its old highs.

Certainly higher fed funds rates and increases would help.

A pullback in the stock to the mid-2015 highs near $35-$36 would be a good opportunity to get longer the name.

Valuation:

Q4 '16 (est) Q3 '16 Q2 '16 Q1 '16
2019 EPS est $2.50 $1.95 $1.80 n/a
2018 EPS est $1.98 $1.72 $1.64 $1.77
2017 EPS est $1.62 $1.52 $1.45 $1.53
2019 exp EPS gro rt 26% 13% n/a n/a
2018 exp EPS gro rt 22% 13% 13% 16%
2017 exp EPS gro rt 25% 19% 17% 22%
2019 PE 16(x) 16(x) 16(x) n/a
2018 PE 21(x) 19(x) 18(x) 16(x)
2017 PE 25(x) 21(x) 20(x) 18(x)
2019 rev est $11.1 $9.8 $9.2 n/a
2018 rev est $9.7 $8.1 $8.9 $9.2
2017 rev est $8.6 bl $8.3 bl $8.1 $8.3
2019 exp rev gro rt 12% 10% 10% 11%
2018 exp rev gro rt 15% 12% 11% 14%
2017 exp rev gro rt 17% 16% 15% 14%
  • Source: internal s/sheet from earnings reports and 10-Q's.
  • Q4 '16 consensus estimates from Thomson Reuters I/B/e/S as of 1/14/17
  • est - estimate
  • exp - expected
  • EPS - earnings per share

Readers should quickly see Schwab is selling at a multiple equivalent to its growth rate, and yet both EPS and revenue estimates have slowly risen over the last 4 quarters.

It is hard to find double-digit EPS and revenue growth in the Financial sector, without a lot of revenue volatility.

Analysis/Conclusion:

The discount brokers of the 1980's and 1990's like Schwab, TD Ameritrade and other less notable brokers, have really become global custodians, and "asset gatherers" as a result of the "3rd party custodian" function to their business, where advisors like myself will custody assets at Schwab and avoid all the compliance of self-custody and the risk of self-reporting.

All clients have been told; having Schwab as an intermediary between me and the client protects the client's interest and financial security.

The old white shoe investment banks like Merrill Lynch, Kidder, Lehman, (you name outside of Goldman and Morgan Stanley) are long gone as they were very slow to adapt to the discount brokerage competition. I remember talking to a client in the mid 1990's where they were still being charged $100 commission to trade IBM at Merrill Lynch, whereas Schwab at that time, was charging $29.95, and that went lower quickly.

The millennials and the "echo-boom" generation should find a good home with Schwab and the TD Ameritrade's given the mutual fund supermarket access, the online familiarity and ease of doing business online, and the one-stop shopping aspect to Schwab's business.

As a Schwab advisor who has custodied client assets at Schwab for the last 22 years, does everything go smoothly? Hardly.

I can go down some rabbit holes with Schwab's support team personnel that get my blood pressure soaring, and make me want to beat my head on the desk from frustration.

The support teams are actually great, and they do their best, but you wind up talking to different people who give different answers about an issue (i.e. to get from point A to point B), and as an advisor you wind up spending a lot of your time and client's time on something that should have been solved very easily.

Watching the big banks trade after reporting earnings on January 13th, while the strong opens were sold off a little, the major banks finished the day in the green.

Readers will rarely be told to buy in front of an earnings report, but if the Financial sector weakens (in terms of price action) in the next few weeks and months, Schwab is a stock for the longer-term, buy-and-hold investor. Schwab is now (or will eventually be) a world-class Financial brand along the lines of the major banks.

Schwab is our largest client financial position and is roughly a 5% weighting within client accounts.

Schwab is well-positioned for the 21st Century and the next generation of investors in my opinion, and the stock is about to exit a 17-year consolidation, from the peak in 1999-2000, to the current day price just 10% below the April 2000 peak.

Disclosure: I am/we are long SCHW, GS, MS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , , , Investment Brokerage - National, , GARP, Market Share Growth
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