We have maintained our Neutral recommendation on The Goldman Sachs Group Inc. (GS) based on the detailed analysis of the company’s first-quarter 2012 results. Goldman’s first-quarter 2012 earnings per share were significantly higher than the Zacks Consensus Estimate. Moreover, the reported earnings almost doubled the prior quarter’s earnings.
Amid the improving economy and global markets, the results of the company were driven by increases in investment banking revenues and equity trading. Moreover, the results were marked by higher client activity levels. However, higher operating expenses were on the downside.
During the first quarter of 2012, encouraging development initiatives such as moves taken by the European Central Bank and other central banks to tackle funding risks for European financial institutions, as well as progress in resolving Greece’s debt situation, helped the global market conditions to improve. Fortifying U.S. economic data also contributed to the enhanced market sentiment, thereby leading to advanced credit markets, increased global equity markets and declining volatility levels in the quarter.
Goldman continues to implement the expense reduction initiatives, which began in the second quarter of 2011. The company launched an internal initiative to identify those areas where it can operate more efficiently. The company has largely implemented its targeted annual run rate compensation and non-compensation reduction of approximately $1.4 billion and continues to identify savings opportunities through declines in total staff and planned expenditures.
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 March 31, 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, recently, the Federal Reserve came up with a set of new 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. According to them, such strict rules will slow down the economic recovery as holding extra cash will limit the availability of credit in the market and would affect the overall business growth.
We anticipate Goldman to benefit from its well-managed global franchise and strong capital base. However, regulatory issues coupled with the fundamental pressures on the banking sector are expected to dent the financials of the company 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. Goldman currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.
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