Charles Schwab (NYSE: SCHW) is slated to report earnings on Thursday, and there is justifiable concern over the obstacles the company is facing and will face for years to come.
The company’s earnings will likely decrease a bit over the next couple of years, but a reasonable TTM P/E of 16.2 shows that the tough times are already priced in. Back in June, I saw a bright future for Schwab after a lean year or two. It may be closer to two lean years, but Schwab will turn it around and reward investors who stick with it.
I’ll start by addressing the obstacles, before showing why the long-term outlook remains bright.
Interest Rates Will Be a Headwind
Back in June, I talked about Schwab’s interest rate sensitivity. To recap: Schwab’s net interest margin business accounts for around 60% of its revenue and a rate change of plus or minus 25 basis points represents a revenue delta of $75 million to $175 million for Schwab.
Well, now the Fed is saying that it will keep interest rates at zero through at least 2023. Of course, nothing is set in stone, but the Fed has changed its policy regime. Previously, the Fed would increase rates in anticipation of higher inflation. This statement from the Fed’s September meeting, which addressed the near-zero interest rates, was instructive:
“It will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”
Schwab Has Cautioned Investors Ahead of Q3 Release
In September, Schwab released its August Monthly Activity Report. The company noted its record $4.49 trillion in client assets, which was up 21% yoy, but cautioned investors ahead of its Q3 release. CFO Peter Crawford addressed the historically low interest rates, saying:
“These dynamics are pushing our third-quarter net interest margin into the upper 130s basis point range, and therefore our third quarter total net revenues are running slightly lower than the company’s second-quarter results.”
Oof. And it’s not as if Q2 was very good. EPS dipped 19% yoy and net interest revenue fell 14%.
But Schwab/TD Merger Will Pay Off Long-Term
At the end of Q1, the Schwab/TD combined company would have had around $4.5 trillion in client assets. Now, after a massive stock market rally, that number is closer to $6 trillion. Additionally, the two have 28 million brokerage accounts and over 5 million daily average trades between them.
The integration will take up to three years, but in that third year, the merger is expected to create up to $2 billion in expense synergies.
This won’t be a stodgy behemoth. It will be a lean machine.
Schwab Has Monetization Options
Schwab is a company with a long track record of innovation and operational efficiency, and I’m betting on them to find another way to effectively monetize their massive customer base in the wake of the interest rate guidance.
Free financial planning is all the rage right now, and Schwab has gotten in on it, but rolling out a paid financial planning option that appeals to millions of its users would be a big win. That’s just one example, but the point is, Schwab has 28 million account holders; there’s a lot of upside if they get this right.
A Near-Term Rally is Possible
Schwab shares spent the summer languishing, while many stocks surged to all-time highs.
Now, I’m not saying that Schwab is going to moon in Q4, but one potential near-term tailwind is the next round of stimulus checks:
A lot of people took their first stimulus checks and opened brokerage accounts. Nothing is done yet, but the political posturing currently going on shouldn’t last too long. Chances are, a deal will be struck and millions of Americans will get another stimulus check. If history is any guide, the issuance of the checks could lead to a boost in new accounts for Schwab in Q4 2020 or Q1 2021.
But the Long Game is Where It’s At
The stimulus checks could give Schwab shares a boost, but it would admittedly be temporary and modest. The real gains are going to come if you buy-and-hold Schwab for a few years. That would give time for:
- The TD acquisition to bear fruit.
- Schwab to figure out an additional way to monetize its customers.
- Interest rates to – hopefully – start going up.
Patience is key with Schwab, but it should pay off handsomely.
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