We have lowered our long-term recommendation on Charles Schwab Corp. (SCHW) to “Underperform” from “Neutral” based on continuous pressure on its net interest margin (NIM) due to a low interest rate environment.
Low interest rate environment continues to be a drag on Schwab’s revenue as the company is highly sensitive to interest rates. Hence, until the economic recovery gains impetus and interest rates rise substantially, we expect the company to continue to experience pressure on NIM and decline in revenues.
Furthermore, Schwab anticipates incremental spending to the tune of $240–$300 million in 2011 as a result of the full-year impact of its Windward acquisition and other project costs including opening of independent branches and new 401(k) offerings. All these would lead to higher operating expenses in 2011.
Though Schwab has been taking initiatives to strengthen its client–advisor relationship, it could experience pressure on declining Daily Average Revenue Trades (DARTs) as a result of a disengagement of retail traders.
On the flip side, in March 2011, Schwab had announced the acquisition of optionsXpress Holdings Inc. in an all-stock deal valued at $1 billion. The deal will likely improve the company’s equities-focused business by expanding into lucrative derivatives trading and fortify its registered investment advisor (RIA) business. Furthermore, the company anticipates revenue synergies of nearly $60 million and cost synergies of about $20 million in the first full year of combined operation.
Also, Schwab maintains a strong capital position, with a focus on low-cost capital structure. Moreover, the company targets its long-term debt-to-total financial capital ratio to be less than 30% (in the first quarter of 2011, the ratio was 24%). Additionally, with the help of its stable capital position, Schwab also continues to pay constant quarterly dividends. Since 1989, the compounded annual growth rate for the company’s quarterly dividend payment has been 26%.
Schwab currently retains a Zacks # 5 Rank, which translates into a short-term ‘Strong Sell’ rating. One of the company’s peers Morgan Stanley (MS) also retains a Zacks # 5 Rank (a short-term ‘Strong Sell’ rating).
MORGAN STANLEY (MS): Free Stock Analysis Report
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