Goldman Tops Estimate, Revenue Down - Analyst Blog

By Zacks | July 17, 2012 AAA

The Goldman Sachs Group Inc. (GS) reported its second-quarter 2012 earnings per share of $1.78, significantly surpassing the Zacks Consensus Estimate of $1.14. Amid the deteriorating global markets and European debt crisis, the results were driven by Goldman's prudent expense management. Yet lower client activity levels acted as a headwind for the quarter.

However, the reported earnings lagged the prior-year quarter's earnings by 7 cents. Moreover, results declined substantially from $3.92 per share recorded in the prior quarter.

Net income applicable to common shareholders in the quarter was $927 million, down from $2.1 billion in the prior quarter and $1.1 billion recorded in the prior-year quarter.

Performance in Detail

Total revenue of Goldman decreased 9% from the prior-year quarter to $6.6 billion, resulting from a decrease in overall businesses, partially offset by higher incentive fees. Moreover, a fall in global equity prices and higher volatility levels during the quarter were the negatives. Revenue also missed the Zacks Consensus Estimate of $6.8 billion.

Quarterly revenue, as per business segments, is as follows:

Investment Banking division generated revenues of $1.2 billion, down 17% year over year. Results reflected lower-than-expected revenues from equity underwriting along with a decrease in revenues from the financial advisory business. However, higher revenues in debt underwriting partially offset the decline.

Investing and Lending division booked revenues of $203 million in the quarter, plummeting 81% year over year. Results principally reflected a loss of $194 million from Goldman's investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), coupled with net losses of $112 million from other investments in equity securities. However, the segment recorded net interest income and net gains of $222 million from debt securities and loans and other net revenues of $287 million.

Institutional Client Services division recorded revenues of $3.9 billion, jumping 11% year over year. Results improved due to outstanding performance in Fixed Income, Currency and Commodities (FICC), marked by increased net revenues in mortgages and commodities.

However, a fall in equity trading revenues (down 12% year over year) due to lower commissions and fees and reduced net revenues in equities client execution, added to the decline.

Investment Management division generated revenues of $1.3 billion, up 5% year over year. The year-over-year rise mainly reflected higher incentive fees, partly offset by decreased transaction revenues and management and other fees.

In the second quarter of 2012, operating expenses descended 8% to $5.2 billion compared with the prior-year quarter. Moreover, lower compensation and benefits added fuel to the fire.

Non-compensation expenses were $2.3 billion in the quarter, down 7% year over year. Expenses decreased largely due to lower levels of business activity and the benefits of continued expense reduction initiatives.

These positives were partially offset by higher impairment charges associated with consolidated investment entities during the quarter. Additionally, results included net provisions of $67 million for regulatory proceedings.

Evaluation of Capital

As of June 30, 2012, Goldman's Tier 1 capital ratio under Basel I was 15%, up from 14.7% in the prior quarter. Tier 1 common ratio under Basel I was 13.1%, improving from 12.9% in the prior quarter.

Return on common shareholders' equity, on an annualized basis, was 5.4%. Goldman's book value per share and tangible book value per share surged to $137.00 and $126.12 from $134.48 and $123.94 respectively, at the end of the prior quarter.

Assets under management (AUM) climbed to $836 billion in the quarter compared with $824 billion in the prior quarter, with $4 billion of net market depreciation and $16 billion of net inflows.

Share Repurchase and Dividend Update

During second quarter 2012, Goldman repurchased 14.3 million shares of its common stock at an average price per share of $104.81 and a total cost of $1.5 billion. Remaining share authorization under Goldman's existing repurchase program stands at 46 million shares.

Concurrent with the earnings release, Goldman declared its quarterly dividend of 46 cents per share. The dividend will be paid on September 27, 2012 to common shareholders of record as of August 30, 2012.

Performance by Peers

Citigroup Inc. C), one of Goldman's peers, after reporting a mixed bag in the prior quarter, reported somewhat encouraging second quarter 2012 results. Earnings per share came in at 95 cents for the quarter, comfortably surpassing the Zacks Consensus Estimate of 88 cents on lower loan loss provisions, higher transaction services revenues and a drop in expenses.

Another peer, JPMorgan Chase & Co. (JPM), proved pessimists wrong second quarter earnings per share of $1.21, way ahead of the Zacks Consensus Estimate of 78 cents. However, this compares unfavorably with $1.27 earned in the prior-year quarter.

Most importantly, due to an imprudent hedging strategy, the company incurred a derivative trading loss of $4.4 billion (before taxes) in its chief investment office (CIO) for the period, exhibiting a two-fold increase from what was disclosed on May 10.

One of the company's strongest peers, Morgan Stanley (MS), will be releasing its second quarter 2012 earnings on July 19, 2012.

Recent Divestiture

Concurrent with the earnings release, Goldman divested Goldman Sachs Administration Services (GSAS), a leading hedge fund administrator to State Street Corporation (STT). The cash deal is valued at $550 million, subject to certain adjustments.

The agreement awaits regulatory approvals and other customary conditions. Moreover, the deal is anticipated to close early in the fourth quarter of 2012.

Our Viewpoint

Overall, the results of Goldman declined compared to the prior period, mainly driven by market turmoil. Although the company has reported profits and decreased operating expenses, lower top-line remains a matter of concern. Moreover, regulatory issues, including lawsuits and the fundamental pressures on the banking sector, are expected to dent the financials of the company in the upcoming quarters.

However, we expect Goldman to benefit from its well-managed global franchise, strong capital base, and industry leading position in trading and asset management in the near future.

In Conclusion

During the quarter, Goldman completed the purchase of Ariel Reinsurance's Bermuda-based insurance and reinsurance operations from Ariel Holdings Ltd. Goldman will combine the acquired business with its existing Lloyd's business. The acquisition will expand Goldman's property and casualty coverage.

Through acquisitions and global expansions, Goldman is trying to capitalize on every opportunity to leverage its strong reputation in the corporate trust market.

An investor with an appetite to absorb risks related to the market volatility should not be disappointed with an investment in Goldman over the long haul. Goldman's fundamentals remain highly promising with a diverse business model and a strong balance sheet.

From the risk perspective as well, it is assured that the company would be able to withstand another financial crisis as Goldman cleared the severest stress test.

Moreover, one can consider Goldman to be a value investment due to its steady dividend-yielding nature. Concurrent with the earnings release, the company also declared the quarterly dividend, instilling investors' confidence.

Goldman currently retains its Zacks #4 Rank, which translates into a short-term Sell rating. However, considering the fundamentals, we maintain a long-term Neutral rating on the stock.

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