(GS) The Goldman Sachs Group Analyst Raises Shares to Neutral

We have upgraded our recommendation on The Goldman Sachs Group Inc. (GS) to Neutral from Underperform based on the company’s cost reduction initiatives and broader outlook for client activity.

In July, Goldman reported second-quarter 2011 earnings per share of $1.85, significantly below the Zacks Consensus Estimate of $2.29. The results deteriorated owing to decreased revenue and poor performance at Institutional Client Services division, coupled with global macro-economic concerns. However, Goldman repurchased 10.8 million shares of its common stock at an average cost per share of $139.20 and a total cost of $1.50 billion during the quarter.

In the current difficult economic and financial conditions, Goldman has taken an internal initiative to identify areas, where the company can operate more efficiently. The company targets about $1.2 billion in run rate compensation and non-compensation reductions through a combination of reductions in total staff and planned expenditures. The company is working on cost reduction efforts and expects to complete them before  end of this year.

Goldman is enhancing its market position globally. With the primary intention of strengthening its business control 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 of providing strong relative return to shareholders. The company proposes to invest for growth in attractive regions and businesses and reduce businesses experiencing lower client demand. Although the outlook remains uncertain, we believe Goldman will continue to adapt to the changes in the economy with the aim of positioning the company for better serving its clients and shareholders.

On the flip side, Goldman experienced decreased client activity during the second quarter of 2011, driven by the uncertainty in economy. Many of the issues bothering the broader operating environment in 2010 continued into 2011, along with the political turbulence in the Middle East and the calamity in Japan adding to their list of woes. 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, and thus, activity levels have generally declined.

Moreover, Goldman is continuously facing fraudulent issues. In August 2011, the company was sued by National Credit Union Administration (NCUA), the U.S. regulator of credit unions, for violating federal and state securities laws and misrepresenting documents as an underwriter in the sale of $1.2 billion in mortgage-backed securities in 2009. Similarly, home and auto insurer The Allstate Corporation (ALL) and bond insurer CIFG Assurance North America Inc. also sued the company for misrepresenting documents as an underwriter in the sale of mortgage-backed securities worth $123 million and $275 million, respectively.

Previously, in July, the company was also sued by several insurance companies for misrepresenting the financial condition of Freddie Mac (FMCC) as an underwriter of Freddie’s offering of Series Z preferred stock in late 2007. We believe the series of such charges will dent Goldman’s reputation and its financials in the future.

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, are causes of concern.

Goldman currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Moreover, Goldman closest competitor – Morgan Stanley (MS) also retains Zacks #3 Rank.

GOLDMAN SACHS (GS): Free Stock Analysis Report

MORGAN STANLEY (MS): Free Stock Analysis Report

Zacks Investment Research

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