Based on substantially lower than expected results and weak fundamentals, we are downgrading our recommendation on Interactive Brokers Group Inc. (IBKR) to Underperform from Neutral.
IBKR’s fourth-quarter earnings of 6 cents per share were substantially short of the Zacks Consensus Estimate of 25 cents. Earnings were also down 87.8% from 49 cents in the prior-year quarter.
As a result of constrained liquidity and other challenges in the market as a whole, IBKR experienced lower operating results during the reported quarter. Results have been largely impacted by competitive pressure on spreads.
However, the balance sheet remained highly liquid with relatively low leverage. IBKR actively managed its excess liquidity and maintained significant borrowing facilities through the securities lending markets and banks. Both revenue and earnings were down sequentially as well as year-over-year.
IBKR’s revenue and profitability significantly depend on trading volume. Total trading volume decreased 2.0% year-over-year during 2009. Low volume in the U.S. or foreign securities and derivatives due to the recent weakness in equity markets would have a materially adverse impact on the company’s business and financial conditions.
Also, IBKR is exposed to certain risks related to its international operations. During 2009, the company generated approximately 32% of net revenues from outside of the United States. Also, its trading gains are geographically diversified. The company generated 41%, 53% and 41% of its trading gains in 2009, 2008 and 2007, respectively, from operations conducted internationally.
Globally, the company faces uncertainty related to political, economic and financial instability; unexpected changes in regulatory requirements; some trade barriers; exchange rate fluctuations; and applicable currency controls.
IBKR’s position with respect to the interface of four broad historical trends is very impressive. The company has positioned itself at the crossroads of globalization, adoption of technology, spread of equity culture and optimal allocation of resources on global electronic networks.
As part of its globalization, the company processes trades in stocks, futures, options and forex on more than 80 exchanges in 19 countries across 14 currencies. Adoption of technology makes the company one of the lowest-cost producers in the industry.
Automation has also resulted in increased profit margins for the company. Unlike many of its peers, IBKR has a very low level of compensation expense relative to net revenues, mainly due to its technological excellence. During 2009, pre-tax profit margin came in at 50%.
IBKR’s strong capital base and highly liquid balance sheet with a low leverage set it apart from its competitors, particularly in view of the ongoing challenges in the markets. The company was able to actively manage its excess liquidity and maintain significant borrowing facilities through the securities lending markets and banks. The company also maintains excess regulatory capital in its broker-dealer companies around the world.
Growth deserves a close watch for the time being, as we remain concerned about IBKR’s dependence on IBG LLC and the risks related to its sizeable international exposure. We anticipate a low volume in the U.S. or foreign securities and derivatives due to the recent weakness in equity markets will negatively impact upcoming results.
Read the full analyst report on “IBKR”
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