We have upgraded our recommendation on The Goldman Sachs GroupInc. (GS) to Neutral from Underperform. The upgraded recommendation is based on the company’s expense reduction efforts amid the current uncertain economy and expansions globally.
In the current difficult economic and financial conditions, Goldman has taken an internal initiative to identify areas, where it can operate more efficiently. The company targets about $1.4 billion in run rate compensation and non-compensation reductions and expects to complete them as soon as possible.
Goldman is enhancing its market position globally. Even in a volatile macro environment, in first half of 2011, the asset-management unit of Goldman agreed to acquire India’s Benchmark Asset Management Co. (BAM), a big provider of exchange-traded funds (ETFs). The acquisition is meant for expansion in Asia’s third-largest economy.
Moreover, with the primary intention of gaining a strong foothold in Australian investment banking market, Goldman adopted a strategy to take full control of Goldman Sachs & Partners Australia Group Holdings Pty Ltd. In April 2011, Goldman bid to buy the remaining stake in the joint venture and received approval in the following month.
In the ongoing challenging environment, Goldman continues to balance near-term uncertainties with longer-term strategic goals. It plans to hold more capital to protect itself against the current macro uncertainties with the commitment to provide strong relative return to shareholders. The company proposes to invest in attractive regions and businesses to enhance growth and reduce the number of businesses experiencing lower client demand.
On the flip side, Goldman experienced subdued client activity during the third quarter of 2011, driven by the uncertainty in economy. Within the U.S., concerns have centered on raising the debt ceiling, a growing budget deficit, persistently high unemployment and potential further pressure on the U.S. housing prices. Therefore, owing to these uncertainties, many of Goldman’s investing clients have significantly reduced their risk exposure, which resulted into a fall in activity levels.
In October, Goldman reported third-quarter 2011 loss per share of 84 cents compared with the Zacks Consensus Estimate loss of 6 cents per share. Results were also significantly below the earnings of $2.98 in the prior-year quarter and $1.85 in the prior quarter. Coupled with the global macro-economic concerns, the results deteriorated due to the decline in revenue and poor performance in all the revenue divisions. However, lower operating expenses partially offset the decline.
Last week, the Federal Reserve came up with a series of new stringent rules for the largest U.S. banking institutions. This step was taken to stabilize the financial system. Moreover, even stricter rules will be implemented for the companies with over $500 billion in assets including JPMorgan Chase & Co. (JPM), Goldman and Citigroup Inc. (C) as they are restricted from entering credit exposure of not more than 10% with any other bank. Through this rule, the Fed will limit excessive interconnections between banks and minimize the risk exposed to a single financial institution as a percentage of the bank’s regulatory capital.
Most U.S. bank officials are in the opposition of the new rules. They opine that such stringent rules will slow down the economic recovery as holding extra cash will limit the availability of credit in the market and would affect business growth.
Fundamentally, we expect the company to benefit from its well-managed global franchise, strong capital base, and industry leading position in trading and asset management. However, regulatory issues, including lawsuits filed against the company, and implementation of new Fed rules are causes of concern.
Goldman currently retains a Zacks #5 Rank, which translates into a short-term ‘Strong Sell’ rating.
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