We are maintaining our Neutral recommendation on shares of Charles Schwab Corp. (SCHW), following the release of fourth quarter and fiscal 2010 results.
Charles Schwab’s fourth quarter earnings came in at 18 cents per share, substantially ahead of the Zacks Consensus Estimate of 10 cents. This also compares favorably with the year-ago quarter’s earnings of 14 cents.
Charles Schwab’s results benefited primarily from a gain in asset management and administration fees, higher net interest revenue and increase in interest-earning assets. However, reduced trading revenue and increased non-interest expenses were the headwinds.
A major part of Charles Schwab’s revenue is generated from commissions. Commission as a percentage of total revenue has substantially improved over the last few years. This has lowered volatility in the company’s earnings and placed it in a better position against some of its peers, who depend more on trading. We expect benefits from retail brokerage, banking, and registered investment advisor (RIA) areas will lead to growth in the company’s market shares in the forthcoming quarters.
Management remains focused on a low-cost capital structure and targets a long-term debt to total financial capital ratio of less than 30%. In 2010, the company’s long-term debt was 24% of total financial capital. Additionally, as a result of its comfortable and overall satisfactory capital position, Charles Schwab is able to pay dividend continuously. The company targets a dividend pay-out ratio of approximately 20–30%.
In November 2010, Charles Schwab had completed the acquisition of Windward Investment Management Inc. Although the deal is not expected to lead to any significant improvement in the company’s earnings, it will act as a growth platform. It is expected to significantly enhance the company’s ability to offer a low-cost, low-priced managed account for both its advisor and retail clientele.
However, Charles Schwab expects nearly $240–$300 million surge in expenses due to the full year’s impact of its Windward acquisition, additional project expenditures including independent branches and new 401(k) offerings and other volume-related costs. Hence, the company’s financials will be impacted by 8% increase in operating expenses in 2011.
Further, Charles Schwab is highly sensitive to interest rates. Low rates have been a drag on the company’s revenue since December 2008, when the Federal Reserve shrunk its benchmark interest rate to a record low of near zero. The company will continue to face a decline in its top-line growth, until the economic recovery gains momentum and interest rates increase significantly – which we do not expect very soon.
Charles Schwab currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Similarly, the company’s closest competitor E*TRADE Financial Corporation (ETFC), also retains its Zacks #3 Rank.
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