There are a number of factors that play a role in discount broker TD Ameritrade Holding Corp.'s (NASDAQ:AMTD) revenue and earnings results each quarter, and a lot of them are outside of the company's control. But at the same time, the company's management has said that by focusing on what it can control, it can put the company in the best position to profit in any market.
It looks like that worked pretty well in the third quarter, reported on July 19, 2016. The company continues to grow client assets, which has helped drive revenue up, while doing an admirable job of keeping costs in line, helping push earnings per share up 25% last quarter. Let's take a closer look at TD Ameritrade's Q3 results.
|Metric||Q2 2016||Q2 2015||Change|
|Earnings per share||$0.45||$0.36||25%|
What happened in the quarter
TD Ameritrade makes money primarily in two ways: Fees from trading activity, and interest on its rate-spread sensitive assets, such as margin loans. The thing is, the company can't really control how volatile the market is (trading activity), or when interest rates will go up. But as outgoing CEO Fred Tomczyk said on the earnings call, "As usual, we stuck to our knitting and remained focused on what we can control. The result was continued growth in each core area of focus."
Here's how the company did in those core focus areas:
- Total client assets were $736 billion, up 5%.
- New client assets were $13.6 billion, up 16%.
- Fee-based investment balances were $164 billion, up 3%.
- Interest rate-sensitive assets were $113 billion, up 10%
The company's bottom line benefited significantly from a tax adjustment in the quarter. The $33 million positive tax liability adjustment added $0.06 per share. Without that adjustment, earnings per share would have increased 8.3%. The company may not be able to influence trading activity or interest rates, but it has clearly done a good job of consistently growing its assets and client base. At the end of the day, the more people use TD Ameritrade as an investing platform, the more trading fees and interest it will get, even as the market fluctuates. But there's a little more to the company's strong profit growth in the quarter.
- Operating expenses increased 4%, well below revenue growth as the company continues to drive more profits with each incremental revenue dollar.
Low interest rates continue to limit the earnings potential of the company's rate-sensitive assets.
- Net interest margin was 1.5% in the third quarter of 2015, but it has steadily declined since and was at 1.41% last quarter. This is partly a product of rates, but also the result of changes to the asset mix that led to lower revenue, even with higher average balances.
TD Ameritrade also said it's well-positioned for the new Department of Labor fiduciary rule, which will be implemented over the next few years.
- Approximately 30% of client assets would be subject to this rule (which covers retirement accounts). Its retail IRAs are mostly self-directed, and its institutional retirement group already operates under the fiduciary standard.
- The company says most of its costs with rule implementation will be for technology and for compliance reporting.
- The company repurchased 1.7 million shares for $49 million last quarter, for an average price of $28.82.
- The company paid a $0.17 per-share dividend in the quarter, the same as the second quarter, and up 13% from last year.
- The balance sheet remained largely unchanged, with no long-term debt and just over $2.3 billion in cash, equivalents, and short-term investments.
TD Ameritrade's business isn't flashy, and its revenue streams are subject to interest rates and market volatility, which I've said ad-nauseum are factors largely outside the company's control. So, management has invested in what it can control, namely managing costs, a strong and popular platform that attracts and retains clients, and positioning the business to benefit from both fee-based activity and the eventual rise in interest rates.
Trading volatility will always chase market sentiment up and down, and it could take years for interest rates to move much higher. But smart investments in growth (marketing costs were up 7% last quarter) have allowed the company to regularly grow revenues, while a steady hand at keeping costs in line has meant profits have routinely increased faster than revenues.
This is the last "official" quarter under Tomczyk, who is retiring at the end of the fiscal year, but by all indications, incoming CEO (and current president) Tim Hockey already has his hands on the reins. Will he keep the company on the same steady path, or will there be changes afoot? Frankly, investors won't really know the answer to that before this autumn, when management rolls out its plans for 2017 and beyond, but wholesale changes seem unlikely.