Schwab's Pricing Cuts May Slash Bottom Line

The bid for market share could take too big a bite out of future profits.
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Reflecting the growing competition in the brokerage industry and tough market conditions,

Charles Schwab

(SCH)

said Tuesday it would reduce pricing for online equity trades and cut commissions for a wide range of clients.

While the move was deemed necessary by analysts, they said it will probably reduce the firm's earnings in 2004 and 2005.

"Schwab's newly announced plans to cut pricing to improve its competitive position will only put greater strain on the company's performance," said Matthew Snowling, an analyst at Friedman Billings & Ramsey.

Snowling, who cut his rating on the stock to underperform from market perform, said the move could hurt the firm financially if it does not increase trading activity and asset flows enough to offset the lost revenue.

Schwab plans to cut commissions on equity trades to $19.95 from $29.95. For customers with over $1 million in assets, commissions will be cut to $9.95 from $29.95. The company, which already produces the lowest returns among its online peers, is also lowering the threshold for some of its account fees, which is expected to reduce fee income.

Schwab said the price cuts could shave 2% to 3% off consolidated revenue in the 12 months after implementation.

Although the cuts improve Schwab's competitive offering and could prevent further market share erosion, Snowling said they won't be enough to win back lost market share. He predicts the company will take a 3-cent-a-share hit to earnings this year, and said profits could be cut by 4 cents in 2005.

Schwab fell 6% to $8.98 on the news while

Ameritrade

(AMTD) - Get Report

was down 2% to $10.72 and

E*Trade

(ET) - Get Report

shed 1% to $11.13.

Competition in the brokerage industry has been fierce this year. E*Trade has already reduced pricing to $12.99 from $19.99 for customers who have $50,000 in assets or trade between 9 and 26 times per quarter. Meanwhile, Ameritrade plans to offer five free ETF trades to promote its new ETF Center in June.

In February,

Fidelity

rolled out $8 flat pricing for customers with $30,000 in assets trading at least 30 times per quarter.

But Snowling said he doesn't expect Schwab's move to trigger further price cuts in the industry. The new $19.95 commission rate applicable to most of Schwab's customers is well above Ameritrade's $10.99 rate or E*Trade's rate of $12.99.

Prudential Securities analyst David Trone, one of the more upbeat analysts on Schwab, maintained his favorable opinion of the stock Tuesday, basing his optimism on the company's accumulation of assets that generate fees.

"The Schwab story is rapidly becoming less about the stock-trade business," he said. "The gap between asset fees and commissions is expanding, and we believe management will succeed in making the latter merely 'gravy.'"

Total client assets at Schwab were $973.7 billion as of the end of April, down 2% from March but up 22% from April last year. Trone said the recent commission cuts will reduce earnings by a penny a share this year and 2 cents in 2005, "which is well within the margin of error associated with predicting" broker's earnings.

Schwab and Ameritrade have both fallen 24% this year compared with a 12% decline for E*Trade. In 2003, E*Trade and Ameritrade more than doubled, while Schwab gained 9%.

Last week, Schwab reported that customer trading activity for the first 10 days of May had fallen 13% from April's daily average of 165,000. On a conference call in April, Ameritrade said trading could slow down over the summer months, as has been the case historically.