We have reiterated our long-term “Neutral” recommendation on Charles Schwab Corporation (SCHW) based on its fourth-quarter results and ability to enhance shareholders value. However, we remain concerned regarding the company’s financials, which will continue to be impacted by lower trading activities and volatile interest rates.
Charles Schwab’s fourth-quarter 2011 earnings were in line with the Zacks Consensus Estimate. Improved trading revenue, lower provision for loan losses and reduced non-interest expenses were among the positives. However, lower net interest revenue as well as asset management and administration fees were the dampeners.
Diversified revenue streams remain the major strength for Charles Schwab. The company’s results continue to benefit from management’s aggressive efforts to increase clients in advisory solutions.
Further, with its stable cash position Charles Schwab has been growing inorganically. Last year, the company closed two major acquisitions. In November, the company completed the acquisition of Compliance11 Inc., which was integrated with its Designated Brokerage Services business. Additionally, in September, the company acquired optionsXpress Holdings Inc. for $1 billion.
However, we are concerned about Charles Schwab’s significant dependence on fee-based revenue streams (41% of net revenues in 2011) and lower degree of capital intensity relative to its peers. Also, the company’s primary revenue drivers have been facing major headwinds.
Further, Charles Schwab’s business model is highly sensitive to interest rates. Low rates have been a drag on the company's revenue. Near-zero U.S. interest rates have forced the company to waive fees it charges to its clients for managing funds. Until the economic recovery gains momentum and interest rates increase significantly, the company will continue to experience a pressure on its net interest margin and a decline in its revenues.
Currently, Charles Schwab retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Similarly, one of its peers E*TRADE Financial Corporation (ETFC) also retains a Zacks #3 Rank.
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