Schwab reported strong Q2 earnings up 8% YoY with an organic asset growth rate of 5%. Investors have been concerned about Schwab’s deposit trends and potential for falling net interest margins due to Fed cutting rates. This quarter’s results seemed to ease some of those fears as trends around Schwab’s deposit base stabilized and outflows from deposits slowed.
Current Price: $ 42.7 Price Target: $53 (20x 2019E of $2.66)
Position Size: 2% Performance since initiation on 6/24/19: 9.1%
Q2 Highlights:
- Core asset growth of 5% for Q2
- Core net new asset growth of $37.2b for quarter and $88.9b YTD
- Growth in Advisor services 9% YoY
- Net interest margin – 2019 still a concern with falling rates
- Deposits up 9.2% YoY, but down 8.5% QoQ due to cash sorting and seasonal tax payments
- Schwab speculated that cash sorting issue is nearing completion as organic net flows to cash sweep turned positive in June
- Net Interest Margin (NIM) was 2.40% up 10 bips YoY. Expects NIM to be 2.35%-2.40% for rest of year
- Managing NIM risks in light of falling yields
- Extending duration to top of range 2.5-2.75 years
- Increasing fixed portion of portfolio to 70% from 60%
- Asset Management and trading
- Schwab Index Mutual Funds AUM $226b up 21% YoY
- Schwab Index ETFs AUM $144b up 25% YoY
- Trading revenue fell 3%, but is only 6% of revenue
- Profitability – industry leader
- ROE 19% and 46.1 pre-tax profit margin
- Expenses up 7% while revenue was up 8%
- Capital allocation
- Repurchased 29.1m shares during quarter for $1.2b. $2.8b remains of authorized buyback. Buyback yield of 2.13%
- Dividend yield of 1.4%
- Shareholder yield of 3.5%
Schwab Thesis:
· Expect Schwab’s vertically integrated business model to drive AUM growth. Schwab has averaged 6% organic core net new asset growth as retail clients and advisors are attracted to Schwab’s low cost trading and custody services.
· Conservative, well-managed firm who is a leader in online trading and focused on leveraging platform.
· Schwab is on the cusp of generating excess capital which they plan to return to shareholders. Expect a 20%-30% payout ratio for dividends (1.7%) and management has approved a $4b share buyback which could amount to 4% to 5% of shares
John R. Ingram CFA
Chief Investment Officer
Partner
Direct: 617.226.0021
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square
Suite 500
Boston, MA 02109