Merrill restarts coverage of online brokerages

NEW YORK Thu Feb 14, 2013 3:54pm EST

A Bank of America Merrill Lynch sign is seen on a building that houses its offices in Singapore May 17, 2012. REUTERS/Tim Chong

A Bank of America Merrill Lynch sign is seen on a building that houses its offices in Singapore May 17, 2012.

Credit: Reuters/Tim Chong

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NEW YORK (Reuters) - After a seven-month hiatus, Bank of America Merrill Lynch reinstated coverage of discount securities brokers, giving the equivalent of a buy, a sell and a hold on the three biggest publicly traded companies.

Analyst Michael Carrier, who joined Merrill in September from Deutsche Bank Securities, on Thursday put a "buy" rating on TD Ameritrade Holding Corp, a "neutral" on Charles Schwab Corp and an "undeperform" on E*Trade Financial.

Merrill had pulled coverage of many bank, brokerage and exchange stocks last June when veteran analyst Guy Moszkowski left the company to open a U.S. research unit for Autonomous, an equities boutique in the United Kingdom.

Five years of rock-bottom interest rates have hindered the profitability of online brokers because they get little return from investing their clients' cash assets and have had to waive fees on money-market funds lest clients realize negative returns.

However, investors have been betting on the brokers as rate plays, believing that those with the most disciplined cost structures and asset-gathering muscle will prosper once the Federal Reserve begins to raise rates.

TD Ameritrade's "strong sales force and product offering" and good expense control should help it grow assets at a rate of 10 percent annually, Carrier wrote. "As we get back to more normal rate backdrop, earnings have the potential to more than double over time."

Carrier estimated that about 50 percent of the Omaha, Nebraska-based company's revenues are rate-sensitive. He gave a $22 price objective target on the company's stock, which was trading on Thursday afternoon at $20.18, up 16 cents. The total return on TD Ameritrade's shares over the past year is 20.9 percent.

Schwab, whose $21.6 billion market value is almost double TD Ameritrade's $10.99 billion valuation, is likely to grow its assets as much 7 percent annually over the next few years and is also "well positioned" for a pickup in rates with a potential for profit to "more than double over time," Carrier wrote.

But the company is using its excess cash for balance sheet growth and small deals, giving it only "modest operating leverage." Schwab's stock has "limited upside," Carrier wrote. He put an $18 price objective on Schwab shares, which were changing hands on Thursday afternoon at $16.90, down 2 cents. The total return on Schwab's shares over the past year is 39.2 percent, including reinvested dividends.

E*Trade, whose shares have had a total return of 23.2 percent, with reinvested dividends in the last year, is "getting ahead of itself," Carrier wrote.

Its ability to generate normal earnings when rates rise is much less certain than at its peers because of bad loans at E*Trade's banking unit.

The company, which last month hired a new chief executive, has made "significant progress" in improving its balance sheet but remains more focused on cost cutting than revenue growth and is constrained by bank capital requirements, he wrote.

Carrier's price objective for E*Trade is $10 a share. Shares were up 8 cents at $11.38 in Thursday afternoon trading.

(Reporting By Jed Horowitz; editing by Carol Bishopric)

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