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We reiterated our Neutral recommendation on The Goldman Sachs Group Inc. (GS - Analyst Report), based on the detailed analysis of the company’s third-quarter 2012 results. Goldman’s earnings per share for the quarter under review were significantly higher than the Zacks Consensus Estimate.
Amid challenging global markets and European debt crisis, the results were driven by Goldman’s record revenues aided by an elevation in client activity. Yet, escalated operating expenses 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. Last year, 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 September 30, 2012, the company exhibited solid risk-based capital ratios. Moreover, in mid-April and again in October, the company announced a 31% and 8.7% hike, respectively, in its quarterly dividend. This reflects the company’s commitment to return value to the shareholders with its strong cash generation capabilities.
On the flip side, during the third quarter of 2012, global economic conditions continued to weaken. After concerns regarding the European sovereign debt risk heightened in the second quarter of 2012 and continued into the beginning of the third quarter, some tailwinds, including central bank actions to ease monetary policy, relieved market pressure. However, concerns and uncertainties about the outlook of the global economy, particularly as it relates to Europe, continued, which resulted in weak investor confidence.
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 - Analyst Report), Goldman, Bank of America Corporation (BAC - Analyst Report) and Citigroup Inc. (C - Analyst Report).
Additionally, in November 2012, the Financial Stability Board indicated that banks would be required to hold an additional Tier 1 common equity as a globally systemically important bank under the Basel Committee’s methodology. Moreover, such stringent capital norms may somewhat restrict the pace of growth in the short term.
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.