Schwab's Acquisitions Are Creating Long-Term Value
We think the shares are undervalued.
While we believe that wide-moat Charles Schwab's (SCHW) earnings will be depressed by the interest-rate environment and messier than normal due to acquisitions in the near to medium term, we believe the company's long-term competitive position and value will be enhanced by its more recent acquisition activity. The firm reported net income to common shareholders of $621 million, or $0.48 per diluted share, for the second quarter on $2.45 billion of net revenue. On an adjusted basis (which excludes acquisition-related expenses), earnings per share were $0.54, a decline of 19% from the prior-year period. Net revenue was down 9% year over year and 6% sequentially, due primarily to $220 million and $183 million respective declines in net interest income. Both short- and long-term interest rates are at multiyear lows and are likely to remain low for years, in our view. As a result, Schwab's organic earnings are in the process of resetting lower over the next year or so. We don’t anticipate making a material change to our $45.50 fair value estimate for the firm, and we assess the shares to be undervalued.
Schwab has been active on the merger and acquisition front the past year, picking up USAA's investment management business, TD Ameritrade, the intellectual property of Motif, and Wasmer Schroeder, with both the USAA and TD Ameritrade deals adding scale. Schwab hit a record $4.1 trillion of client assets at the end of the second quarter, with $80 billion coming from the USAA acquisition and the rest due to the stock market recovery. The TD Ameritrade merger, which is the largest and most important of the recent deals, should close in the back half of 2020; we recently updated our fair value estimate for the combined companies to reflect over $10 billion of merger synergies derived from account expense synergies, revenue synergies from moving client cash into Schwab's bank, and merger dissynergies from client attrition, margin loan rates, and payment for order flow.
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Michael Wong does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.