High Rates & Strategic Buyouts Aid Schwab Amid Rising Expenses

Charles Schwab Corp. SCHW remains well-positioned for growth, driven by higher rates, opportunistic acquisitions and rising client assets. However, a mounting expense base and subdued trading revenues are worrisome.

Tailwinds for Schwab

High Interest Rates to Aid Net Interest Margin: Schwab's net interest margin is likely to improve in the near term, supported by the existing high-interest rate scenario. The company's NIM expanded to 1.98% in 2023 from 1.78% in 2022 and 1.45% in 2021 on account of high rates. However, due to rising funding costs, NIM did not experience growth in the first half of 2024.

Though high funding costs and low-yielding assets on the company's balance sheet are anticipated to weigh on the metric to some extent, high rates will likely aid NIM to some degree. We project NIM to be 2.13%, 2.83% and 3.13% in 2024, 2025 and 2026, respectively.

Strategic Acquisitions to Boost Client Assets: Schwab's proactive efforts to expand its client base in advisory solutions have been bearing fruit. The company's advice solution revenues reflected a compound annual growth rate (CAGR) of 10.4% in the last five years (2018-2023). The momentum continued in the first six months of 2024.

The acquisitions of USAA's Investment Management Company, Wasmer, Schroeder & Company, LLC and Motif's technology and intellectual property have strengthened the company's presence and diversified revenues.

Though the company reduced fees on certain advice solution products, revenues from these offerings witnessed growth as average client asset balances improved. SCHW's total client assets experienced a 21.2% CAGR in the five years ended 2023, primarily driven by the buyouts completed during the period. Our estimates for total client assets suggest a CAGR of 6.2% by 2026.

Encouraging Capital Distributions: As of June 30, 2024, SCHW's cash and cash equivalents were $25.4 billion, while total debt (comprising long-term debt, Federal Home Loan Bank borrowings and other short-term borrowings) was $56.8 billion.

The company's emphasis on keeping a low-cost capital structure has been supporting its capital distributions. In January 2023, the company announced a 14% hike in its quarterly dividend and has retained the same since then.

Dividend Yield

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The company has hiked its dividend four times in the past five years. While SCHW has an existing share repurchase plan, it has been temporarily halted to enhance liquidity and reduce debt. The company aims for a common dividend payout ratio of 20-30% of GAAP earnings. Schwab's earnings strength and decent liquidity will keep the capital distributions sustainable.

Roadblocks for Schwab

Mounting Expense Base: Rising operating expenses are likely to hamper Schwab's bottom line. Though expenses dipped in the first half of 2024, the metric witnessed a 17.5% CAGR in the past five years (ended 2023). This rise was due to high compensation, benefit costs and acquisitions.

Expense Growth Trend

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While management anticipates adjusted operating expenses to rise only 2% this year, the company is expected to continue investing to bolster long-term growth and solidify business efficiency. Further, costs tied to compensation and regulatory spending, as well as strategic buyouts, are anticipated to keep operating expenses elevated in the near term.

Expenses are expected to decline 5.1% in 2024, but rise 2.3% in 2025.

Subdued Trading Revenues: Though the capital markets performance has improved recently, Schwab's trading revenues are anticipated to remain under pressure for some time.

The company's trading revenues dipped in 2022, 2023 and the first six months of 2024 because of subdued market volatility and reduced client activity. However, SCHW has been undertaking several initiatives and opportunistic buyouts to build a client base and enhance its trading income.

Nonetheless, the uncertainty surrounding the performance of the capital markets raises concerns regarding potential growth in trading revenues. Additionally, the ongoing geopolitical environment suggests that volatility and client activity are unlikely to see significant improvement in the near term.

SCHW currently carries a Zacks Rank #3 (Hold). Year to date, shares of the company have lost 7.6%, underperforming the industry's growth of 14.2%.

Year-to-Date Price Performance

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Schwab's Peer Stocks Worth Considering

Some better-ranked Schwab's peers' stocks worth considering are Robinhood Markets, Inc. HOOD and Interactive Brokers Group, Inc. IBKR.

Estimates for HOOD's current-year earnings have been revised 38.2% upward in the past 60 days. The company's shares have risen 33.1% in the past six months. HOOD sports a Zacks Rank #1 (Strong Buy) at present.

Estimates for IBKR's current-year earnings have remained unchanged in the past month. The company's shares have risen 21.6% in the past six months. IBKR carries a Zacks Rank #2 (Buy) at present.

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