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Morningstar | TD Ameritrade Looks at Expense Control to Partly Offset Revenue Headwinds; New CEO Search Begins

Narrow-moat TD Ameritrade is taking an approach similar to peers by emphasizing expense control as revenue headwinds are fairly clear. Additionally, the company is looking for a new CEO, as current CEO Tim Hockey will only be staying with the company through February 2020. Little information was given as to why Hockey and the board have decided to look for a "new leader to guide its next phase of growth." The Scottrade integration seems to have gone well, and earnings headwinds are a factor of the overall macroeconomic environment, so we believe the current management team has done a decent job. We may modestly decrease our $62 fair value estimate as we factor in the deterioration in interest rates since our previous valuation update and potential effect of a bear market.

While there are headwinds to earnings, TD Ameritrade's fiscal third quarter ended June was fairly strong. The company reported non-GAAP net income of $578 million, or $1.04 per diluted share, 14% higher than a year ago. About 80% of the $109 million increase in net revenue from the previous year, to $1.49 billion, came from net interest income and bank deposit account fees. With most market analysts predicting that the Federal Reserve will reduce the federal-funds rate one to three times this year and with the 10-year Treasury near 2.05% compared with an average closer to 3% in the fourth quarter of 2018, net interest income and bank deposit account fees that had been earnings tailwinds are likely to turn into headwinds. If the fed-funds rate is cut 25 basis points, the company estimates pretax earnings will decrease $0 to $75 million over the next 12 months.

To partly counteract revenue headwinds, management seems to be focusing a bit more on costs. The company announced it is closing 80 branches, or about 20% of its branch footprint. Additionally, it may reduce its 2%-4% core expense growth guidance for fiscal 2020.

We find it reassuring that online brokerage peers seem to be following a similar playbook. Charles Schwab also recently reduced its expense forecast. There's a feeling that if all of the online brokerages face revenue headwinds on the interest-rate-related revenue side of their business, they may not compete as aggressively on the commission pricing side and may decrease the rate they pay on client cash deposits to try to preserve their net interest spreads.