Charles Schwab: A Case Of Mistaken Panic (NYSE:SCHW)

Buy The Panic-Driven Discount

We believe The Charles Schwab Corporation (NYSE:SCHW) has been overly sold at these levels, negatively impacted by the banking crisis over the past two weeks. Particularly, we think the pessimism is unwarranted since SCHW is primarily a brokerage company, with a value-added banking service to support its clients’ asset management.

SCHW has been a provider of financial services, specializing in brokerage accounts with $7.38T (-6.1% YoY) in managed assets as of March 17, 2023, expanding by +4.2% from December 2022 levels of $7.05T. Particularly, only 11.7% (-0.2 points YoY) of the assets were comprised of cash as of February 2023, attributed to its clients’ transactional balances from their brokerage accounts.

Even if there were any ‘bank runs,’ about $25.8B (-14.2% YoY) of checking and savings/other deposits were at risk, comprising only 7% of the company’s $366.72B bank deposits in FY2022. Particularly, 91% of its bank deposits were tied up in deposits swept from brokerage accounts for stock and securities trading. Furthermore, less than 20% of its deposits exceeded the FDIC insurance limits of $250K.

Therefore, SCHW’s risk management is much improved, in our opinion, compared to SVB Financial (SIVB) at an uninsured deposit ratio of 88%, JPMorgan (JPM) at 56%, Bank of America (BAC) at 37.9%, Citigroup (C) at 85.2%, and Wells Fargo & Company (WFC) at 36.8%.

Furthermore, SCHW’s expanding liquidity coverage ratio [LCR] of 123% (+17 points YoY) demonstrated its excellent liquidity sources, with $93.98B (-20% YoY) of High-Quality Liquid Assets (HQLA) in FY2022. This was on top of the $300B of additional liquidity from the Federal Home Loan Bank [FHLB] and the recent Bank Term Funding Program (BTFP), suggesting the company’s more than sufficient liquidity in covering the current bank deposits.

While there were some concerns about the decline in the company’s Bank Deposit Account [BDA] balances by -7% YoY to an average of $147.27B in FY2022, we must also highlight that it recorded higher BDA fee revenues of $1.4B at the same time, expanding by +7.1% YoY.

Furthermore, the decline was mostly attributed to the clients’ rotation from the company’s bank to the company’s CDs/ treasury bills/ money market funds with higher yields, with the total assets remaining stable. Therefore, it was apparent that SCHW’s well-diversified offerings resonated well with its clients, no matter the macroeconomic outlook, preventing the migration of funds to competitors.

In addition, the banking crisis over the past two weeks had only demonstrated the clients’ growing trust in the management’s forward execution, with the brokerage company receiving $16.5B of core net new assets between March 10 and 16, 2023, averaging at $3.3B daily. The acceleration was notable indeed, compared to the February 2023 daily average of $2.02B and the January 2023 daily average of $1.58B.

Therefore, we are cautiously confident that SCHW need not realize the losses in its Available-For-Sale [AFS] securities at $12.29B (+150.8% YoY) and in its Held-To-Maturity [HTM] securities at $15.58B in FY2022.

The company’s net revenue also expanded by 12% YoY to $20.8B in FY2022 as well, with the net interest revenue growing by 33% YoY to $10.68B, comprising 51.3% of its revenues compared to FY2021 levels of 43.3%. The sum was impressive indeed, attributed to the rising interest rates thus far.

Therefore, it makes sense that SCHW has been expanding its non-GAAP Return on Tangible Common Equity [RoTCE] (to 42% in FY2022, compared to 22% in 2021). This was triggered by the acceleration in its net income growth by +22.7% YoY to $7.18B as well.

Our optimistic sentiment is significantly aided by its excellent FQ1’23 guidance of a GAAP pre-tax profit margin of up to 43%, compared to FQ1’22 levels of 39.4%. With the interest rates likely to continue rising to a terminal rate of 5.5%, we reckon SCHW may outperform the market, based on analysts’ prudent projection of net revenue growth CAGR of 8.8% and EPS of 15.9% through FY2024, significantly aided by its expanding asset base.

In the intermediate term, if/when the Fed starts cutting rates, we reckon its unrealized losses in the existing securities may moderate as well. This may also potentially help alleviate the pressure coming from the company’s funding sources at an average rate of 0.26% in FY2022, compared to 0.09% in FY2021. Only time may tell.

So, Is SCHW Stock A Buy, Sell, or Hold?

SCHW 1Y Price/Sales and P/E Valuations

SCHW is currently trading at a Price/Sales of 4.71x and NTM P/E of 13.57x, lower than its 3Y pre-pandemic mean of 5.94x and 19.31x, respectively. Otherwise, it is still moderately lower than its 1Y mean of 6.24x and 16.67x, respectively.

Based on its projected FY2024 EPS of $5.24 and current P/E valuations, we are looking at a moderate price target of $71.10, suggesting an excellent upside potential of 26% from current levels.

SCHW 5Y Stock Price

SCHW has been overly beaten down in our view, with the stock drastically plunging by -26.3% to $56.41 at the time of writing, nearing its February 2021 lows and June 2018 heights. Particularly, the stock is also trading way below its 50, 100, and 200-day moving averages.

Based on its annualized FQ1’23 dividends of $1.00, we are also looking at an improved forward yield of 1.77%, against its 4Y yield of 1.32% though still lower than the sector median of 3.03%.

Therefore, we recommended interested investors should add SCHW stock here.