Interactive Lags on Lower Revenue

Interactive Brokers Group Inc.’s ( IBKR - Analyst Report ) third quarter 2012 earnings per share of 26 cents substantially missed the Zacks Consensus Estimate of 35 cents. In addition, this compares unfavorably with the year-ago quarter’s earnings of 48 cents.

After considering the effect of changes in the U.S. dollar value of Interactive’s non-U.S. subsidiaries, earnings came in at 30 cents per share compared with 34 cents in the year-ago quarter.

Results were impacted by fall in net revenue, partially mitigated by lower operating expenses. Moreover, the performances of the Market Making segment and Electronic Brokerage segment were not up to the mark in the reported quarter.

Net income available to common shareholders was $12.5 million, plummeting 44.4% from $22.5 million in the year-ago quarter.

Quarter in Detail

Interactive’s total net revenue came in at $318.6 million, declining 17.4% year over year from $385.6 million. The dip was primarily attributable to lower interest income along with significant fall in trading gains as well as commissions and execution fees, partially mitigated by higher other income and lower interest expenses. Net revenue was 3.2% lower than the Zacks Consensus Estimate of $329.0 million.

Net income before taxes dropped 20.8% year over year to $172.6 million. Similarly, pre-tax profit margin fell from 56% in the prior-year quarter to 54% in the reported quarter.

Total non-interest expenses were $146.0 million, down 13.0% from $167.8 million in the prior-year quarter. The decline was mainly due to lower execution and clearing expenses along with general and administrative costs. However, these were partially offset by higher employee compensation and benefits expenditure as well as communications costs.

Segment Performance

Market Making: Net revenue decreased 24.6% to $154.1 million from $204.3 million in the prior-year quarter. Pre-tax income fell 29.8% year over year to $90.2 million as a result of adverse Market making environment including declining exchange traded volumes, lower actual to implied volatility and tighter bid/offer spreads in options. Further, pre-tax profit margin declined to 59% from 63% recorded in the year-ago period.

Electronic Brokerage: Net revenue deteriorated 12.6% year over year to $167.6 million. Similarly, pre-tax income stood at $80.8 million, falling 23.4% from the year-ago quarter. Pre-tax profit margin was 48% compared with 55% in the prior-year quarter. Additionally, total daily average revenue trades (DARTs) for cleared and execution-only customers declined 21.0% year over year to 390,000.

Balance Sheet

As of September 30, 2012, cash and cash equivalents (including cash and securities segregated for regulatory purposes) was nearly $14.0 billion, up 18.9% from $11.8 billion as of December 31, 2011. Total assets recorded were $33.9 billion in the quarter, up 11.4% from $30.4 billion as of December 31, 2011.

Total equity came in at $5.1 billion as against negative equity of $0.5 billion as of December 31, 2011.

Dividend Update

Concurrent with the earnings release, Interactive’s Board of Directors declared a quarterly cash dividend of 10 cents per share. The dividend will be paid on December 14, to shareholders of record as of November 30.

Our Viewpoint

In spite of the lower-than-expected results, we believe that Interactive’s robust fundamentals and liquid balance sheet will continue to boost investors’ confidence in the stock. The company’s Market Making segment funds its dividend payment. However, off late the segment is underperforming and that makes us wary about its ability to consistently generate sufficient returns to fund dividend payment. In addition, Interactive’s better-than-peer positioning and technological excellence makes us optimistic about its future.

However, with lower trading activity in the markets, Interactive’s financials may get adversely affected since its revenue is highly dependent on the trading volume at the stock exchanges.

Interactive currently holds a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term ‘Neutral’ recommendation on the stock.

Among Interactive’s peers, GFI Group Inc. ( GFIG - Snapshot Report ) is expected to announce its third quarter results on October 23.