Robinhood Stock: Wall Street Is Not Ready For X1 (NASDAQ:HOOD)

Amidst a surge in speculative stocks, Robinhood (NASDAQ:HOOD) has seen its stock run up as well. The company appears to be benefitting from a win-win situation: higher interest rates have led to a surge in interest income and profitability, while the prospects for interest rate cuts might lead to increased trading revenues and higher valuation multiples. HOOD continues to hold a bulletproof balance sheet highlighted by over $5 billion of net cash and I expect top-line growth to accelerate as the company adds new financial products to its platform. Investors may be counting out HOOD stock due to its reputational hit amidst the pandemic, but the company may be positioning itself for a surprising turnaround. Even considering the higher valuations today, I continue to stand by my buy rating for the stock.

HOOD Stock Price

The last month has seen a stunning surge in the prices of speculative stocks, with HOOD now trading around 52-week highs.

I last covered HOOD stock in October where I rated it a buy on account of the strong balance sheet and the ongoing turnaround. Investors continue to underestimate the company’s ability to win further market share moving forward.

HOOD Stock Key Metrics

In its most recent quarter, HOOD saw assets under custody (‘AUC’) pull back 2% sequentially due to market fluctuations, though I expect AUC to move sequentially higher in the next quarter given the recent market rally.

HOOD saw net revenues grow 29% YoY but fall 4% QoQ. While net interest revenues have continued to rise, transaction-based revenues fell for the second straight quarter.

We can see a breakdown of transaction-based revenues below – the company is most well known for commission-free equity trading, thus it makes sense that it derives the majority of its transaction-based revenues from options trading.

I expect the next quarter to see solid if not stronger transaction-based revenue growth given the recovery in crypto trading volumes as well as the stable equity and options volumes reported in November.

The most important story of the past many quarters has been the surge in net interest revenues. The rising interest rate environment has led to growth in interest revenues from not only margin and customer cash balances, but more importantly from the company’s corporate cash balance.

The company had previously seen adjusted EBITDA turn negative in late 2021 and early 2022 due to a plunge in transaction-based revenues. The surge in net interest revenues has helped the company report 5 straight quarters of positive adjusted EBITDA.

The company would have posted its second straight quarter of GAAP net income if we exclude $104 million in regulatory accrual.

HOOD repurchased 55 million shares in the quarter from Sam Bankman-Fried’s Emergent Fidelity Technologies, spending just over $600 million on the transaction. That led to shares outstanding declining by 5.3% YoY.

HOOD ended the quarter with $5.4 billion in corporate cash, down from $6.3 billion sequentially (primarily due to the share repurchase mentioned above). The lower cash balance may pressure net interest revenues in the near term – on the conference call, management guided for roughly a $20 million sequential decline in net interest revenues.

Management highlighted their optimism in Gold subscriptions driving future growth. HOOD is offering a 5% APY on uninvested cash and a 3% match on IRA contributions for Gold members. Management notes that Gold memberships are growing rapidly at 21% over the past year. 6% of all HOOD customers are Gold subscribers and roughly 12% of new customers are Gold subscribers. Gold subscribers on average have greater average AUC and are more likely to open IRAs with the firm. This kind of paid membership model is quite well known but it is impressive that HOOD has been able to utilize it to such effect in spite of its reputational hit during the pandemic.

I expect greater momentum as HOOD unveils new products. HOOD acquired X1 credit card in July and as a credit card junkie myself, I would not be surprised if a highly promotional offering regarding credit card rewards rates is able to jump start AUC and revenue growth. Management stated that an X1 credit card offering may be available for Gold customers in early 2024.

Is HOOD Stock A Buy, Sell, or Hold?

Nowadays, it can be easy to forget that HOOD was once a revolutionary brokerage firm that paved the way for commission-free trading industry practices. Behind the scenes, HOOD has been delivering on new product features, with 24 Hour Market being a recent innovation.

After the recent run-up HOOD was trading just a hair over 6x sales.

Consensus estimates call for just 9.7% revenue growth in 2024 with a quick deceleration thereafter. Based on 30% long term net margins and a 1.5x price to earnings growth ratio (‘PEG ratio’), that might imply a valuation of around 4.4x sales. HOOD stock might not look that attractive compared against that target, but there are two key points to remember. First, HOOD’s $5.4 billion net cash balance represents around 47% of the market cap. Second, the main bull thesis for HOOD lies in its ability to return to being a leading brokerage firm, which should mean faster revenue growth rates. Assuming a return to 20% top-line growth, HOOD might be fairly valued at around 9x sales, implying considerable multiple expansion upside in addition to an attractive long term growth setup. HOOD appears to be struggling in consistently growing AUC in large part due to its reputation for being just for aggressive traders, I do not see any inherent reason why that reputation must stick indefinitely. HOOD is widely known for having an attractive user interface, something that is suspiciously uncommon among brokerage firms. As a digital-first company, HOOD may benefit from the typical cost savings of lower fixed cost overhead, but more importantly the company appears heavily motivated to innovate in an industry that has historically seen minimal innovation. Sure, other brokerage firms may be able to replicate much of their innovations (the prevalence of commission-free trading is one prime example) but that misses the point – customers may wish to bank with a firm that is leading the change, while also offering generous perks like higher APY and IRA matches. I expect the X1 credit card to be a turning point for the company – I expect HOOD to offer something like 3% cash back for Gold subscribers with future requirements based on assets at the firm. Bank of America (BAC) has something similar at Merrill Edge with their Preferred Rewards program, and I expect HOOD to experience greater success given their arguably stronger focus on brokerage innovation. I view HOOD as being similar to TikTok in that it is resonating with newer investors, with payoffs that should accelerate over time as these newer investors earn higher pay checks and invest with greater capital.

What are the risks? Growth might take a while to accelerate, if ever. I am currently not too concerned from a financial risk point of view due to HOOD’s GAAP profitability (albeit slim), but if interest rates were to decline without an associated increase in transaction-based revenues, then time may become an enemy. The company’s large net cash balance sheet would buy some time in that case, but that would be eventually unsustainable given that the strong balance sheet makes up such an important part of the bullish thesis. The stock valuation is not so attractive unless top-line growth accelerates meaningfully or the company can demonstrate mature profit margins sooner than expected. The company’s entrance into credit cards may present credit risk (though HOOD would be presumably trying to attract high net worth individuals). The company’s association with cryptocurrencies may lead to “black swan” risk similar to what was seen at regional banks earlier this year.

While there is the risk that HOOD is brought down in the event of a broader selloff, I reiterate my buy rating for the stock.