Continued Upside For The World's Leading Investment Bank

Sep.12.13 | About: Goldman Sachs (GS)

Though shares have risen 29.95% YTD, Goldman Sachs Group, Inc.'s (NYSE:GS) upside growth potential is still not tapped, with potential intermediate-term downside of only 9% based on a book value of $151.21. The company has traded at a 12% discount on a two-year historical equity relative value basis.

Goldman Sachs is a global investment banking, securities and investment management firm that provides a range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. The company has been active in acquiring new assets. In May 2013, Goldman Sachs (Singapore) Pte Ltd, a unit of Goldman Sachs, acquired a 6.7% stake in Keppel Reit. The company also acquired a 5.03% stake in Echo Entertainment Group Ltd. In July 2013, Suncorp Group Ltd announced the completion of the non-core portfolio sale to the Company. Effective August 6, 2013, Goldman increased its interest by acquiring an 18.7% interest in Red de Carreteras de Occidente SAB de CV, a unit of Goldman's Goldman Sachs Infrastructure Partners fund, from Empresas ICA SAB de CV.

Investment Banking

GS's investment banking division offers a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds and governments. For the second quarter of 2013 (Q2 2013), the investment banking segment has generated $1,552 million in revenues, up 29% over second quarter 2012 (Q2 2012), and essentially unchanged in comparison to the first quarter of 2013 (Q1 2013). Particularly good was the underwriting business, increasing 45% in comparison to Q2 2012. The increase reflects significantly higher debt underwriting revenues (a record quarter), due to leveraged underwriting; as well as equity underwriting, reflecting an industry-wide increase in activity.

Year-to-date, Goldman Sachs ranked first in worldwide announced and completed M&A. GS's most important transactions that closed in Q2 2013 were News Corporation's approximately $9 billion spin-off of its publishing business, Hess's $2.1 billion sale of its Russian subsidiary to Lukeoil, and Siemens's GBP 1.7 billion acquisition of Invensys Rail. The company is also an advisor to a number of recently announced significant transactions, including: Canada Safeway's C$ 5.8 billion sale to Sobeys, Springer Science and Business Media's EUR 3.3 billion sale to BC Partners; and Lender Processing Services $4 billion sale to Fidelity National Financial

Institutional Clients Services

This segment facilitates client transactions and makes markets in fixed income, equity, currency and commodity products, primarily with institutional clients such as corporations, financial institutions, investment funds and governments.

Revenues in this segment were $4,313 million for the Q2 2013, up by 10.9% from the same quarter last year. The good results of the quarter reflects the broad contribution across businesses and the diversified franchise of the company. However, the quarterly results felt a slight negative impact by increasing interest rates and widening credit spreads, which noticeably eroded a large chunk of Goldman's debt trading profits, something the bank itself expected at the end of last quarter.

Investing & Lending

The company's Investing & Lending segment invests in debt securities and loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities and originates loans to provide financing to clients.

Revenue from investing & lending in Q2 2013 is up by 700% in comparison to Q2 2013, but it is down by 32% in comparison to Q1 2013. The volatility of this segment's results is due, in large part, to the fact that the segment's operations involve direct investments in stocks of other companies, among other things. Therefore, results can vary drastically from quarter to quarter.

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Investment Management

This segment of the company offers investment products (mutual funds, private investment funds) to institutional and private clients and wealth advisory services.

The revenue for this segment was $1,332 for Q2 2013, staying exactly the same as Q2 2012. There was an increase in management and other fees, due to the higher assets base under supervision; however, this was offset by lower incentive fees, which are linked to how the fund performs (i.e. the returns on assets under management).

Expenses

The Company's total operating expense for Q2 2013, increased to $5,967 million, from $5,212 million for the same quarter last year. This is because the greatest portion of the expense is compensation & benefits, which is directly linked to the performance for the quarter. Compensation & benefits were 27% higher in Q2 2013 as compared to Q2 2012; but, as a percent of net revenue, compensation & benefits has decreased from 44% in Q2 2012 to 43% in Q2 2013. The decrease is a result of total staff decrease of exactly 1%.

The non-compensation expenses were essentially unchanged.

Share Repurchase

The below table details share repurchases of the company for the second quarter of 2013.

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As can be seen in the table, even as the price per share has increased month over month, Goldman has continued to repurchase shares.

Company Comparable Analysis

I have used Morgan Stanley (NYSE:MS), JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), and the industry averages for this comparison.

Goldman ranks below most of the competitors in market capitalization, however, the company primarily focuses on investment banking and trading; whereas the other banks have major retail banking services operations and huge mortgage business.

Goldman is cheap on a P/E valuation basis, having a much lower P/E ratio than the industry average and has a remarkable return on equity. Thus, it can be said that Goldman does a phenomenal job in returning value-for-money to investors.

Goldman, ranks slightly below the dividend yield industry average, but the company does not lag behind the primary competition; a result of continually increasing dividends year over year.

Valuation

The company's basic earnings per share (EPS) for the H1 2013 is $8.45 ($7.99 diluted EPS), compared to $5.90 basic EPS ($5.72 diluted EPS) for H1 2012. The earnings forecast for the second half of 2013 ranges from $5.94 to $9.05, with a consensus forecast of $7.52. If we take the consensus forecast we arrive at a FY 2013 EPS of $15.97. I still believe that this is a pretty conservative outlook given the fact that, historically, the second half EPS have been higher than the first half. With an estimated forward P/E ratio of 10.65 the Company is worth at least $170.

The company's book value was $151.21 (tangible book value of $141.62) per share at the end of Q2, up 5% YTD. The company is trading at a P/TBV multiple of 1.16, whereas the average industry multiple is 1.63. Given that only a 9% decline in the price of the stock will result in a trade at its tangible book value, coupled with its higher P/TBV industry average multiple, my money is that the stock price will continue to increase in the near future.

Conclusions

Going forward, I expect earnings to grow somewhere from $15 to $16 per share in 2014. During the financial crisis Goldman was able to acquire market share due to major banks' losses. Now the company must become more dependent on its own operations, rather than on economic cycles. Moreover, the company is steadily increasing its dividends.

Given that earnings has grown faster than revenues in the last couple of years, it can be concluded that the company is operating more efficiently and has managed to reduce costs.

In addition, Goldman has an international presence and reputation, and its brand recognition in the eyes of institutional investors is giving the company a competitive advantage that will ensure good deal flow.

Goldman Sachs presents a lucrative long-term investment opportunity in the financial sector. It has done an outstanding job returning value to its shareholders and will continue to do so.

Disclosure: I am long GS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.