Credit Suisse Starts Charles Schwab at Outperform, Sets $55 Price Target

Charles Schwab's focus on the client, along with rising interest rates and more money going into its proprietary bank, should bode well for its prospects in the New Year and beyond, prompting Credit Suisse to initiate coverage on The Charles Schwab Corporation (SCHW​) stock with an Outperform rating and a $55 price target.

In a research report to clients, Credit Suisse analyst Craig Siegenthaler said that the San Francisco-based discount brokerage's client-centric business strategy should enable it to generate "significant" value for its investors. He pointed to large bulk transfers as adding to earnings in a big way. A bulk transfer happens when the brokerage moves clients' cash from a money market fund or third-party bank to its own bank. Siegenthaler said that large bulk transfers could net Charles Schwab EPS appreciation of 15% to 30% over 2017 EPS levels.

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The analyst noted that, over the past decade, Schwab has completed $50 billion of bulk transfers, which add 150 basis points of return on client assets per every $1 transferred. Staring in the first quarter of 2018, it will transfer $70 billion during the next two years. Those plans, noted the analyst, could be affected by Schwab's Tier 1 leverage ratio, which is currently at 7.7%. The regulatory requirement is 5%. "We think Schwab could initially transfer $15-20 billion in 1H18 before needing additional capital, which it would generate each quarter," the analyst wrote. With Schwab stock currently trading at $55 per share, Credit Suisse expects the stock price to increase more than 14%. Schwab shares were recently down 0.20%, or $0.10, to $48.69.

The Wall Street analyst believes that most of the price cuts to online equity commissions are over and that Charles Schwab could use pricing to prevent a potential merger between TD Ameritrade Holding Corporation (AMTD) and E*Trade Financial Corporation (ETFC). Credit Suisse expects Schwab to have "high organic growth" during the course of the next five years, which could result in EPS growth of 15% to 20%. On top of all that, Siegenthaler said that interest rate increases by the Federal Reserve will be a positive for Schwab, given its large and growing bank. He pointed to Schwab's guidance for a $200 million to $300 million increase from the next 25-basis-point increase in the Fed rate, with $200 million assuming no change to long-term rates and $300 million assuming a change.

From a valuation perspective, the analyst said that Schwab stock appears "attractive" based on the broker's earnings potential and when compared with the market. He expects Schwab's EPS to experience "abnormally high growth in 2018-2019" owing to bulk transfers and rising interest rates. Credit Suisse believes that growth will moderate in 2020 to 2025, and the firm expects Schwab shares to trade above $70 by 2020.