SCHW/Schwab: Relatively Reasonably Valued Even After Doubling In The Last Year
Long Only, Long-Term Horizon, Growth, Growth At A Reasonable Price
Seeking Alpha Analyst Since 2018
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Summary
- The stock price of Charles Schwab and Company has doubled over the last year.
- The company's long term record of consistent growth, the synergies from the TD Ameritrade acquisition, and the bottoming out of interest rates will drive near term earnings.
- Valuation, after adjusting for the earnings and synergies of the Ameritrade acquisition, is still reasonable on both a historical and absolute basis.
Overview
The stock price of Charles Schwab and Company has doubled over the last year. However, the company's long term record of consistent growth, the synergies from the TD Ameritrade acquisition, and the bottoming out of interest rates will drive near term earnings. Valuation, after adjusting for the earnings and synergies of the Ameritrade acquisition which closed on October 6, 2020, is still reasonable on both a historical and absolute basis. I do not believe the stock is over-valued, and will be holding onto my position.
The Company's long record of consistent growth
The company has grown its number of accounts steadily over the years. However, even more relevant to a long-term shareholder is the number of accounts per share (i.e., the accounts each shareholder "owns" after stock buybacks), which has steadily increased since 2015, and jumped with the close of the Ameritrade acquisition--sold orange line).
While assets per account has fallen following the acquisition of Ameritrade (dashed orange line), which indicates that the average AMTD account has fewer assets than SCHW's, interest earning assets--the spread on which SCHW derives a large portion of its revenues--have grown as a percentage of assets (dashed blue line).
The short term negative is the decline in interest rates (solid blue line)-- an exogenous factor resulting from the Federal Reserve's response to COVID-19--which has caused revenues growth to weaken.
Looking at the same metrics but from a shareholder's perspective, the per-share assets, interest earning assets, and accounts have all expanded over the last 6 years as SCHW continued to benefit from consolidation in the brokerage industry.
Financials and synergies from the Ameritrade acquisition
In SCHW's fall business update, Schwab COO Joe Martinetto reiterated the $1.8-$2 billion expense reduction synergy target from the acquisition of AMTD, and noted that there would also be revenue synergies from bank deposit account balances in addition to the expense reductions.
For the year ended December 2020, SCHW incurred or charged integration-related costs and amortization of acquired intangible of $632 million:
Upon the realization of acquisition expense synergies and adjusting for integration/amortization expenses (but not for revenue synergies), SCHW's operating income should be ~$2.5 billion higher.
SCHW and AMTD's summary financials are as follows:
Using 9/30/2020 pre-acquisition financials, the pro-forma combined adjusted income (before revenue synergies) would be:
9/30/2020 (in 'MM) |
comments |
|
|
SCHW: Operating Income adj: acq/integ costs adj: amortization |
$4,072 +160 +43 =4,275 |
$442-282 for 1st 9 months $190-147 for 1st 9 months |
|
AMTD: Operating Income add: synergies |
$3,000 $1,900 =$4,900 |
(mid-range of $1.9-$2b synergies) |
|
TOTAL: SCHW + AMTD Operating Income Net Income |
$9,175 $6,881 |
(sum of adj. op income) (assume 25% tax) |
The obvious concern is the elimination of trade commissions from trades, which would ostensibly wipe out a large source of SCHW and the industry's historical revenues. However, there is an ancient Chinese saying that the wool comes from the sheep's back--i.e., nothing comes for free. In this case, SCHW gets compensated by providing lower returns on one's cash balances held in the account (the average account typically holds ~11-15% in cash), and receiving "order flow revenues".
The note in fine print at the bottom of page 6 of the 4Q2020 earnings release states that:
[for the convenience of those who need reading glasses: (1) Beginning in the first quarter of 2020, order flow revenue was classified from other revenue to trading revenue. Prior periods have been reclassified to reflect this change]
Account productivity should rise with interest rates
Revenue to assets and revenue per account both declined from 2019 onwards due to the Federal Reserve's lowering of interest rates under pressure from President Trump followed by COVID-19. However, it is likely that rates have hit bottom, and Federal Reserve Chairman Jerome Powell has already warned of the possibility of a temporary rise in interest rates to ward off the risk of inflation as the economy re-opens after the COVID lockdowns. Higher interest rates result in higher spreads for SCHW, which will help boost net interest revenue.
Valuation:
The company's 2020 reported earnings only incorporates one quarter of AMTD earnings (technically, one quarter less 6 days as the transaction closed on October 6). After adjusting for the full year benefit of AMTD earnings, acquisitions synergies, one-time integration/amortization expenses, the company's net income settles in at about $6.8 billion, resulting in a more reasonable PE of ~20x, which is closer to the low-end of SCHW's 10-year historical PE multiple. Furthermore, there is the potential for an earnings boost from interest rate increases as economic growth resumes as the economy re-opens with the rollout of COVID-19 vaccines.
In conclusion:
I'm reluctant to add to my position after a stock doubles in a year, but I believe SCHW is relatively reasonably priced. I will be holding onto my SCHW stock for the intermediate future, and plan to increase my position when there are sharp pullbacks.
Analyst's Disclosure: I am/we are long SCHW.
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