We reiterated our Neutral recommendation on The Goldman Sachs Group Inc. (GS), based on the detailed analysis of the company’s second-quarter 2012 results. Goldman’s earnings per share for the quarter under review were significantly higher than the Zacks Consensus Estimate.
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.
Despite the current difficult economic and financial conditions, Goldman continues to focus on improving operating efficiencies and reducing operating expenses. A year ago, the company announced a $1.2 billion expense initiative and subsequently increased the amount to $1.4 billion. After meeting that target, Goldman continues to focus on improving operating efficiencies across the firm. Currently, Goldman targets about $500 million in additional annual run rate compensation and non-compensation reductions, which is expected to be completed by year-end.
The company aims to maintain a strong capital position in order to instill the confidence of clients, the investors, bank regulators and stockholders. Sturdy capital ratios depict Goldman’s financial strength. As of June 30, 2012, the company exhibited solid risk-based capital ratios. Moreover, in mid-April, the company announced a 31% increase in its quarterly dividend. This reflects the company’s commitment to return value to the shareholders with its strong cash generating capabilities.
On the flip side, during the second quarter of 2012, global economic conditions weakened, driven by the decline in real gross domestic product (GDP) in Europe, while it augmented at a slower pace in the United States and Japan. After positive developments during the March quarter, concerns regarding the European sovereign debt risk mounted due to the political unrest in Greece and apprehensions regarding the fiscal outlook in Spain and Italy. These conditions weighed on the investment banking activity, particularly in equity-related underwriting activity levels.
Moreover, in June 2012, the Federal Reserve came up with a new set of stringent rules for the largest U.S. banking institutions. This step was taken to stabilize the U.S. financial system. The Fed governors proposed capital reserves of 7% of the risk-weighted assets of the banks. Wall Street biggies to be affected by such rules include JPMorgan Chase & Co. (JPM), Goldman, Bank of America Corporation (BAC) and Citigroup Inc. (C).
Most of the U.S. bank officials are opposing these new rules. They are anxious that such strict norms will slow down the economic recovery as holding extra cash will limit the availability of credit in the market and would disturb the overall business growth.
We anticipate Goldman to benefit from its well-managed global franchise, strong capital base and recent investments. However, regulatory issues coupled with fundamental pressures on the banking sector are expected to dent its financials in the upcoming quarters.
We believe that the risk-reward profile of Goldman is currently balanced and hence, we have reiterated our Neutral recommendation on its shares. However, Goldman currently retains a Zacks #2 Rank, which translates into a short-term Buy rating.
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