Charles Schwab: Increasing Fair Value to $80, as We Have More Comfort With Earnings Trajectory

We are increasing our fair value estimate for wide-moat-rated Charles Schwab SCHW to $80 from $70, as we have gained more comfort with the trajectory of the company’s earnings after the effects of client cash sorting. At the end of the second quarter of 2023, deposits from banking clients stood at $304 billion compared to a peak of $466 billion at the end of the first quarter of 2022. Clients have sorted their cash from low interest-yielding sweep deposits into higher yielding products, such as money market funds. The outflows of deposits caused Charles Schwab to rely on higher cost funding sources, such as certificates of deposits and Federal Home Loan Bank system loans, to manage its bank balance sheet. The higher cost funding led to net interest income declines over the previous two quarters.

After further analysis of prior periods of high interest rates, historical Charles Schwab and TD Ameritrade client behavior, and recent data on money market fund flows, we believe that Charles Schwab is turning the corner with its high-cost supplemental funding needs that will boost net interest income and have greater comfort with the range for the company’s long-term deposit balances. While the eventual cutting of interest rates by the Federal Reserve will bring with it another period of pressure on net interest income, we forecast multiple years of double-digit earnings growth after net interest income resets.