Author: John Ingram

Schwab Q4 2019 results

Last week, Schwab reported Q4 earnings of $.62, slightly missing estimates of $.64. Despite the headline miss, results were solid with healthy organic asset growth of $66.2b for Q4 representing full year growth of 7%. Total client assets rose to $4.04T, surpassing the $4 trillion mark for the first time. Asset growth should remain healthy heading into 2020 with the expected closing of two acquisitions – USAA Investment Management and TD Ameritrade.

Current Price: $ 48.45 Price Target: $53

Position Size: 2% Performance since initiation on 6/24/19: 24.8%

Q4 Highlights:

  • Core asset growth of 7% for 2019
    • Core net new asset growth of $66.2b for quarter and $211.7b YTD
    • Growth in Advisor services 10% YoY
  • Net interest margin
    • Deposits grew qoq from $208.6m to $211.1m as cash sorting (moving sweep assets into other higher yielding vehicles) pressures abated
    • Net Interest Margin (NIM) was 2.34% decreased only 9bips given lower rates.
  • Asset Management and trading
    • Schwab Index Mutual Funds $323.3b up 30% YoY
    • Schwab Index ETFs $163.8b up 42% YoY
    • Trading revenue fell to $86m down 58%, but is only 6% of revenue
  • Profitability – industry leader
    • ROE 19% and 45.2 pre-tax profit margin
    • Expenses up only 5%
  • Capital allocation
    • Repurchased 6.4m shares during quarter for $230m. $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

($SCHW.US)

[category: Equity Earnings]

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

www.crestwoodadvisors.com

Berkshire Hathaway Q3 2019 earnings

On 11/2/19, Berkshire Hathaway (BRK/A, BRK/B) reported Q3 earnings increase of 3.9% to $8.5b with strength in Insurance and Railroads. Sales increased 2.4% year over year. Berkshire’s collection of insurance companies and investments is unmatched and generates ~$8.8b in cash a quarter.

Current Price: $220 Price Target: $240 (raised from $225)

Position Size: 3.3% TTM Performance: 0.8%

Thesis Intact. Key takeaways from the quarter:

  1. Cash balances rose to hefty $128b or $50 a share for B class. BRK’s cash has risen from $60b in 2014. The high cash levels are a drag on earnings growth and have historically been criticized in the press. However, high cash levels are symbolic of Buffett’s patience as an investor and that market valuations are above average.
  2. Geico earnings rose, but saw similar profitability trends as Travelers with higher costs relating to severity of claims. Basically, the car insurance industry is paying more in liable claims which are dragging down profitability.
  3. Since 2018, headline earnings on BRK include unrealized gains on their equity portfolio. Before this mandated accounting change, gains were realized when positions were sold. When evaluating performance best to look at operational earnings which exclude the noise from changes in stock prices.
  4. Sum of the parts valuation is supportive of current price and suggests more upside, especially if excess cash is invested.

The Thesis on BRKB:

  • Berkshire Hathaway has assembled an enviable portfolio of companies and investments that can compound book value per share in the mid-upper single digits.
  • Negative cost of float gives it leverage to invest in stable companies that increases cashflow
  • High cash levels put Berkshire in great position to deploy capital.
  • Earnings from operating companies are stable and growing
  • Berkshire is trading at an attractive valuation

Thanks,

John

$BRK/B.US

[tag BRK/B]

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

www.crestwoodadvisors.com

Travelers Q3 earnings report

On 10/21/19, Travelers reported Q3 EPS of $1.43, well below consensus estimate of $2.34. Shares sold off ~8% on the earnings miss. Travelers missed earnings due to increases in reserves in their business segment due to higher than expected losses in asbestos claims and higher tort cost for general liability and auto. The rising costs appear to be an industry trend. In response business policy renewal rates have increased to 7.4% which Travelers expects will offset the higher cost trend and restore profitability. Travelers seems to be early/leading the industry with increases in reserves.

Travelers is a high quality, disciplined underwriter of insurance that is focused on returning capital to shareholders through dividends and share buybacks. Insurance earnings are historically volatile, so we are maintaining price target and weight, expecting that Travelers will return to its profitability trend.

Current Price: $131.43 Price Target: $155

Position Size: 2.16% TTM Performance: 10.9%

Thesis Intact. Key takeaways from the quarter:

  1. Higher losses on tort related expenses

· Generally, insurance companies record revenue in one period and hold reserves to pay for claims in future periods. If they reserve more than they pay out in claims, the excess reserves will be released as earnings. The reverse happened this quarter for Travelers as claim trends were higher than expected which required an increase reserves.

· Q3 saw adverse development in asbestos claims of $228mm, in general liability of $114 and commercial auto of $134 primarily due to inflation on tort related settlements.

  1. TRV continues to aggressively return capital to shareholders – for 2019 year to date TRV returned $1.8b to shareholders out of $1.8b in earnings
    • Over past 10 year shares outstanding have fallen 53%!
    • Shareholder yield of 7.1% = 2.5% dividend and 4.6% share buyback
    • Management employing capital wisely! Instead of investing in mature business with spotty pricing, they are returning excess capital to shareholders
  1. Some positives in the quarter
    • Importantly, Travelers is increasing prices significantly – up 7.4% – to offset higher costs of future claims
    • Record net premiums of $7.569b up 7%
    • Book value per share $99.21 up 14% from year end 2018
    • Q3 ROE of 6.2% with YTD ROE of 9.6%

4. Valuation of 13 P/E is slightly above the median of its five-year valuation range of 10 – 15.

The Thesis on TRV:

  • We expect TRV will be able to grow book value per share in the mid-single digits over the near-medium term, and generate ROE in the 10-14% range
  • Industry leader with disciplined underwriting and investment portfolio track record
  • Consistent returns in the low to mid double digits
  • Responsible capital allocation and proven desire to act in the best interests of shareholders

Please let me know if you have any questions.

Thanks,

John

($TRV.US)

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

www.crestwoodadvisors.com

Schwab cuts trading fees to zero

Hi,

Yesterday Schwab announced that they would eliminate commissions on trades for all US stocks and ETFs. The surprise move sent SCHW shares down 10% and sent ripples across other online trading companies. For Schwab trading revenue has been declining for the past decade. They advertise discount trading to grow assets under management (AUM). They have been the leader in reducing costs and pressuring the competitors to follow.

For Schwab trading revenue is only 6-7% of total revenue which is far less than Ameritrade or IBG both whom collect more than a third of their revenue from trading. Clearly, Schwab is placing a lot of pressure on competitors and some consolidation is expected. Yesterday, Ameritrade’s stock fell by over 20%.

Our thesis for buying Schwab focuses on growth in AUM, not trading revenue. Schwab estimates they could lose $400m in revenue through zero commissions which could be replaced by $20b gain in deposits. Schwab has grown deposits by more than $20b annually over the past 3 years. Deposit growth is driven by AUM growth and the amount of cash held by investors. Cash levels are near market cycle lows, so an increase in market volatility (fear) could raise cash levels and benefit Schwab’s bottom line.

Since we bought Schwab, interest rates have fallen significantly. Considering Schwab’s interest revenue is 73% of total revenue, the effect of a decline in interest rates on net margin is important – much more important than trading revenue. We expect some contraction in net interest margin, but also expect Schwab to manage costs by keeping deposit yields low. Schwab’s strategy to gain assets is to give away trading, while Fidelity has been advertising higher yields on money markets funds.

Schwab reports Q3 on 10/15, which will give us greater insight on AUM growth, deposit growth and net interest margin.

Please let me know if you have any questions.

Thanks,

John

$US.SCHW

[tag Equity Research]

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

www.crestwoodadvisors.com

Schwab Q2 Results – fears around stock are abating

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

www.crestwoodadvisors.com