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Goldman Sachs: Troubles Ahead

|Includes: Bank of America Corporation (BAC), GS, JPM
Summary

Goldman Sachs did not end the year on a great note or have a great quarter.

1Q2019 Earnings will be a high pressure test for Goldman Sachs as 1Q2018 Results were very strong.

GS does not have a strong diversified pipeline of products like its competitors.

If you want to buy in to GS, I would recommend doing so after 1Q2019 Earnings have been released, as GS stock will likely take a hit.

For stability right now, JPM and BAC are better choices.

New CEO David Solomon was just in charge of a great quarter (or so people seem to think…) for Goldman Sachs and will face the issue of the scandal in Malaysia soon. Thanks to my attempt at being more behavioral, I bought into Goldman Sachs at its low point in end of December 26. Respectfully, I’m not agreeing with other writers that Goldman Sachs just had a great quarter. I also can’t confidently consider GS as still undervalued after falling below the $230 price ranges a few months ago.

Now, as a person who cares a lot about revenue growth, the famous firm will start to slow down in coming quarters of 2019, even though earnings have increased 7% over the past 5 quarters. Recently as many investors and news readers saw, Goldman Sachs announced a big positive 35% surprise in quarterly earnings of 6.04 per share over 4.45. But this was thanks to the reduced estimates for banks of 4th quarter 2018, with an average industry cut of -9%. Estimates for Goldman Sachs took the biggest cut with a 27% decrease.

Troubling Quarter...

In terms of its business, the declines in areas specifically the 18% decline compared to 4Q2017 in fixed-income and commodities section are troubling. With troubling markets, assets under management fell by $47 billion from the 3rd quarter. The data shows that there were more client activity in the Fixed Income and Institutional Client segments, but this was offset by difficult market conditions. With strong M&A activity in the market, investment banking revenues were still only up 7% Y/Y versus 2017.

Investment Banking Investment Services Equities Lending Investment Management
2018 vs. 2017 7% 13% 15% 14% 13%
Q/Q vs. 3Q2018 3% -22% -11% -6% 0%

If anything, Goldman Sachs did most of the rest of the year well, and due to December market troubles...did not end with a great quarter.

Compared to Competitors:

Operating expenses grew 12% Y/Y for Goldman Sachs, much higher than competitors JP Morgan (3% Y/Y) and Bank of America (unchanged). Expenses increased largely due to higher compensation and benefits expenses: bankers who are rainmakers make a large amount of money in bonuses. The large increase in expenses came from investments used for the growth: marketing costs and the investment in Marcus.

GS JPM BAC MS
Operating Expense Growth Y/Y 12% 3% 0% 3%
Net Revenue Growth Y/Y 12% 8.4% 4% 5.7%

However compared to the other banks, Goldman Sachs did decent. 12% growth in net revenue Y/Y is stronger than competitors Morgan Stanley (5.7%) and JP Morgan (8.4%). In terms of fundamentals, Goldman Sachs has increasingly worked on its free cash flow. 13.3% in Return on Equity is the highest ROE since 2009.

Risks:

I’m actually not very worried about the scandal in Malaysia. If anything, I think after a while, everyone will forget about it. It’s definitely not the first time GS, or banks, have faced scandals.

  • Now, right off the bat, I think GS will take a hit after 1Q2019, since the performance of 1Q2018 was very strong. It’s not that surprising, as GS has been showing a declining trend in earnings estimates for the past 5 quarters. If I had to just guess (forecast) a revenue growth in 2019, it will be flat if not a slight decline. I suspect analysts will decrease their Whatestimates for all banks in the coming quarter.
  • GS is playing catch up by diversifying in other areas such as launching Marcus, an online platform offering no fee personal loans and high-yield savings accounts to consumers, in 2016. But compared to JP Morgan and BAC, GS just doens’t have as well of a diversified pipeline of products.
  • While GS stock tends to move in line with the market when the market is trending up, the share price tends to drop more than the index and is more volatile than a majority of companies in the S&P500. We shall see how David Solomon leads the famed institution as strong M&A business benefitted GS with Solomon having worked many areas in the segment, but revenue could be see issues if the market does not keep up. Revenue could be boosted as GS still continues to try and ramp a better consumer business.

What's Ahead?

Net Revenue Net Earnings
4Q2018 $8,080M 2,538M
1Q2018 $10,036M 2,832M

With continuing volatile market conditions, Goldman Sachs will be under high pressure to perform as 1Q2018 was a very strong quarter.

Overall:

On the bright side,I think Goldman Sachs will continue to build momentum with strongly growing segments in debt securities (43% Y/Y) and investment management (13% Y/Y) driven by record growth in assets under supervision and fees.

We shall see how David Solomon leads the famed institution as strong M&A business benefited GS with Solomon having worked many areas in the segment, but revenue could be see issues if the market does not keep up.

I expect Goldman Sachs to end the year with a price target range of $180 - 195.

Disclosure: I am/we are long GS.

Additional disclosure: I am a growth investor who does hold Goldman Sachs. This article is meant for discussion and to let others see that Goldman Sachs did not have a great quarter to end the year.