Based on Interactive Brokers Group Inc.’s (IBKR) strong capital base and low balance sheet leverage, we have raised our long-term recommendation from “Underperform” to “Neutral”.
Interactive Brokers’ second quarter 2010 earnings of 9 cents per share significantly lagged the Zacks Consensus Estimate of 21 cents. This also compared unfavorably with the prior-year quarter’s earnings of 31 cents.
Results were mainly marred by a negative top-line growth, increase in non-interest expenses and constrained liquidity. However, Interactive Brokers’ balance sheet remained highly liquid with a low leverage which distinguishes it from its peers.
Interactive Brokers leads the way in developing and applying technology as a financial intermediary in the capital markets in which it operates. The company has been successful in enhancing the liquidity and transparency in its operating areas, which has made it one of the low cost broker-dealer service providers. Further, the company is also able to adjust its systems to comply with various restrictions imposed by the Securities and Exchange Commission (SEC) due to its technological advantage.
As a part of its growth strategy, Interactive Brokers processes transaction in stocks, futures, options and forex on more than 80 exchanges across 19 countries and 18 currencies. The company also continues to explore new high growth markets in emerging countries such as India, Mexico and Taiwan. This has resulted in more than 50% of the new clients coming from outside the U.S., leading to a greater diversification of revenues.
However, Interactive Brokers’ profitability largely depends on trading volume on the bourses. A low volume of trade in securities and derivatives due to a weakness in equity markets can hurt the company’s business. Total trading volume decreased 2.0% year over year during 2009.
Further, Interactive Brokers’ dependence on IBG LLC is also a cause of concern. The company has 10.5% equity interest in IBG LLC, which is its primary asset. Interactive’s controlling interest and related rights as the only managing member of IBG makes Interactive Brokers dependent on revenue generation. IBG’s inability to provide sufficient funds to pay taxes or for any other purpose would significantly affect Interactive Brokers’ financial condition.
Interactive Brokers shares currently retain a Zacks #4 Rank. This translates into a short-term ‘Sell’ rating and indicates a slight likelihood of downward pressure on the shares over the near term.