Goldman Beats on Fundamentals - Analyst Blog

The Goldman Sachs Group Inc.'s (GS) fourth quarter 2010 earnings per share of $3.79 outpaced the Zacks Consensus Estimate of $3.73. In spite of challenging economic conditions, the company stood to gain from a solid balance sheet and global clients. Goldman's results were nevertheless affected by poor performance in Investment Banking and significantly higher operating expenses.

Net income in the quarter was $2.4 billion, compared with $1.9 billion in the prior quarter and $4.9 billion in the prior-year quarter.

For full year 2010, the company reported earnings per share of $13.18, slightly ahead of the Zacks Consensus Estimate of $13.13. Excluding the impact of $465 million related to the U.K. bank payroll tax, $550 million related to the SEC settlement and $305 million related to the impairment of the company's New York Stock Exchange (NYSE) Designated Market Maker (DMM) rights, earnings per common share were $15.22. Net income was $8.4 billion, compared with $13.4 billion in the prior year.

Behind the Headlines

Total revenue of Goldman decreased 3% from the prior quarter and 10% year over year to $8.6 billion. Revenue reported was below the Zacks Consensus Estimate of $9.2 billion, primarily due to lower equity trading. For full year 2010, the company reported revenue of $39.2 billion, down 13% year over year and also below the Zacks Consensus Estimate of $39.9 billion.

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

Investment Banking division generated revenues of $1.51 billion, down 10% year over year. Results reflected lower-than-expected revenues from the financial advisory business as a fallout of a decline in client activity. These declines were further exacerbated by lower revenues from both equity and debt underwriting due to lower levels of activity.

Institutional Client Services division recorded revenues of $3.64 billion, down by a significant 31% year over year. Results deteriorated due to a decrease in revenues in equity trading (down 5% year over year) and a decline in Fixed Income, Currency and Commodities (FICC), signifying a challenging environment during the reported quarter and lukewarm client activity.

Investing and Lending division booked revenues of $1.99 billion, up by a substantial 45% year over year. Results principally reflected a gain of $55 million from Goldman's investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), a net gain of $1.07 billion from other equity securities and a net gain of $537 million from debt securities and loans.

Investment Management division generated revenues of $1.51 billion, up 14% year over year. The year-over-year increase mainly reflected extensively higher incentive fees, partially offset by lower transaction revenues.

In the fourth quarter of 2010, operating expenses doubled from $2.24 billion in the prior-year quarter to $5.17 billion. The considerable rise in expenses was perpetrated by higher non-compensation expenses. For fiscal year 2010, operating expenses increased 4% from $25.3 billion in the prior year to $26.3 billion.

Non-compensation expenses were $3.05 billion in the quarter, up 11% year over year. Expenses increased largely due to an impairment of Goldman's NYSE DMM rights of $305 million during the quarter, as well as higher market development expenses and professional fees. For fiscal year 2010, non-compensation expenses increased 14% from $9.15 billion in the prior year to $10.43 billion.

Evaluation of Capital

As of December 31, 2010, Goldman's Tier 1 capital ratio under Basel I was 16.0%, up from 15.7% as of September 30, 2010. Tier 1 common ratio under Basel I was 13.3%, compared with 13.0% as of September 30, 2010. As of fiscal year ended 2010, return on equity, on an annualized basis, was 11.5%.

For fiscal year 2010, Goldman's book value per share improved 10% year over year to $128.72. Tangible book value per share increased 9% year over year to $118.63.

Assets under management (AUM) increased 2% sequentially to $840 billion in the quarter due to $12 billion of net appreciation and $5 billion of net inflows.

Share Repurchase and Dividend Update

During fiscal year 2010, Goldman repurchased 25.3 million shares of its common stock, at an average cost per share of $164.48, for a total cost of $4.16 billion. In the fourth quarter of 2010, the company repurchased 6.7 million shares at an average cost per share of $163.41, for a total cost of $1.09 billion.

Goldman declared a dividend of 35 cents per share payable on March 30, 2011 to common shareholders of record as of March 2, 2011.

Performance by Peers

Comparing performances in Goldman's peer group, Citigroup Inc. (C) reported positive results though lagging the Zacks Consensus Estimate. The lower-than-expected results were primarily due to a drop in revenues. Citi reported a decrease in both interest and non-interest revenues. The revenue figure included a negative Credit Value Adjustment (CVA) of $1.1 billion that resulted from tightened spreads. Additionally, there was also an escalation in expenses. However, the decrease in loan loss provisions, in sync with expectations, was the bright spot.

Another of the company's peers,JPMorgan Chase & Co. (JPM), however reported fourth quarter earnings substantially ahead of the Zacks Consensus Estimate. For full year 2010 as well earnings surpassed the Zacks Consensus Estimate. The better-than-expected numbers were primarily supported by higher non-interest revenue and a slowdown in provision for credit losses, which more than offset a rise in non-interest expense primarily because of increased litigation reserves.

A strong contender Morgan Stanley (MS) will be releasing fourth quarter earnings on January 20, 2011.

Our Take

Though most of the major banks had to absorb extraordinary shocks from the recession, Goldman remained consistently profitable during the economic downturn. This resiliency in its business model and the strength of its fundamentals will see the company through the ill effects of the recent financial reform law and in spite of the continuing pressure on trading revenues.

Fundamentally, we expect the company to benefit from its well-managed global franchise, strong capital base and leading position in investment banking, capital markets, trading, and asset management business. While the new financial regulatory reform will remain a challenge for Goldman's top line, we believe its measures to strengthen the business model while complying with such regulatory changes are encouraging.

We therefore expect Goldman to continue to deliver strong performance, based on its prudent business model and strong fundamentals. Goldman currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we are maintaining our Neutral recommendation on the stock.

 
CITIGROUP INC (C): Free Stock Analysis Report
 
GOLDMAN SACHS (GS): Free Stock Analysis Report
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
MORGAN STANLEY (MS): Free Stock Analysis Report
 
Zacks Investment Research