Goldman Sachs (GS) investors were eagerly looking for impulses coming from the release of Q2 2012 results, as the stock was hit hard in the 2nd quarter of 2012 with a 30% decline in share value. Marking a high in April at $139.25, the stock has corrected significantly making investors wonder how strongly economic uncertainty is affecting Goldman's profitability.
Key take-aways from Goldman's Q2 2012 earnings call are encouraging, despite temporary setbacks. Goldman Sachs reported:
- Revenues of $6.6 billion and income of $962 million
- Diluted EPS of $1.78 (-3.8% decline compared to Q2 2011)
- Return on equity of 5.4% for the second quarter and 8.8% for the first six month of 2012
- BVPS increased 2% to $137
- High Tier 1 common ratio of 13.1%
- High consistent league table rankings in profitability driver M&A
Despite a 12% decline in net profit, which was mainly driven by weaker investment banking revenues, Goldman beat analysts revenue- and earnings estimate by about 2%. Cyclicallity in profitability is not only affecting Goldman Sachs: Both JP Morgan (JPM) and Citigroup (C) reported declines in their second-quarter profit with earnings down 9% at JPM and 12% at Citigroup.
Having a look at the individual business segments at Goldman Sachs continues to show the underlying strength of its business model:
Investment banking revenue was $1.20 billion, 4% higher than the first quarter but 17% lower than Q2 2011. Uncertainty especially hit Financial Advisory revenues which are down 26% compared to Q2 2011 and underwriting sales down 9% compared to a year ago. This segment is the most important as well as most volatile in Goldman's business. Investors should expect volatility in revenues and earnings, but should not extrapolate. The deviation of underlying earnings is not straightforward and should ideally encompass the entire business cycle.
Institutional Client sales stood at $3.89 billion, up 11% compared to Q2 2011 and FICC revenues were up 37% hitting $2.19 billion on a y-o-y comparison.
To no surprise, the decrease in global equity prices led to a difficult environment for Goldman's equity service line with revenues of $1.70 billion which is 12% lower than in Q2 2011. Revenues and earnings of the Equity segment are highly dependent on the future economic outlook. Investors should expect considerable volatility in GS's earnings going forward. I believe this segment to have tremendous upside when economic conditions improve.
Investing and Lending produced a loss of nearly $200 million based on the decline in value of ICBC holdings and a loss of $112 million from other investments.
Investment Management posted 13% higher revenues compared to Q1 2012 which came as a surprise to me as I was expecting a 10% decline in this segments' revenues due to higher competition between asset managers. In fact, only higher incentive fees were responsible for the positive q-o-q growth with overall management fees and transaction revenues being lower.
In addition, the company proactively addressed the cost structure to mitigate risks coming from an uncertain macro environment,which is exactly what I want to see as a shareholder: Opex are down 8% compared to Q1 2011 and 23% lower than the previous quarter in 2012 with more cost reduction programs on the way to make GS' cost structure leaner and more efficient.
CEO Blankfein addressed concerns about weaker revenues, particularly in investment banking, head on:
During the second quarter, market conditions deteriorated and activity levels for both corporate and investing clients were lower given continued instability in Europe and concerns about global growth.
Investors should be keenly aware, that Goldman Sachs is a cyclical play whose business performance is highly correlated with the development of the economy in general and the capital markets - equity and debt - in particular.
A temporary weakness in fundamentals is not due to Goldman Sachs losing ground, but to overall economic conditions that will revert to the mean over the next cycle. In my opinion, investors should buy into cyclical companies when fundamentals speak against them temporarily. Since the stock is still significantly undervalued, P/E of 7.8 and P/B of 0.67, I reiterate my Strong Buy rating for GS common stock based on the released Q2 2012 numbers. Investors are advised to use stop loss limits to reduce losses in case the economic picture worsens and causes losses for financial firms.