Goldman Sachs Group Inc (GS)

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Goldman Sachs: Taking Profits Before Potential Disappointments
By: Seeking Alpha | December 4, 2019

Goldman Sachs (GS) is up 27% year-to-date as investors look forward to the company's first ever Investor Day on 29 January. I've outlined the fundamentally negative view I hold of GS in previous articles (here and here) and it hasn't changed. It revolves around my belief that the pivot away from its historic institutional trading-based business model and into new businesses such as consumer banking and mid-corporate lending will take much longer to deliver results than the market thinks.

The bulls have pointed to the Investor Day as a chance for the company to show-case the upside in new activities like Marcus, the consumer deposit and lending platform, and Apple Card. However, it looks increasingly as if we've already enjoyed the best of the ride in terms of the share price pop the event can deliver and I see a growing risk it will fail to live up to expectations with negative consequences for the share price.

The ratcheting down of expectations has already begun
What makes me nervous is the increasing volume of comments in the press lately from "sources close to the company" trying to take the steam out of investors' expectations.

• The Financial Times reported this week that GS will avoid setting strict profitability targets and will focus instead on less concrete "through the cycle" goals for metrics like ROE and cost:income. It also reported that management will try to steer attention back to the company's core businesses rather than the new initiatives in consumer banking and credit cards, acknowledging that "it was not remotely possible for the consumer businesses to generate material earnings in the next five years".
• Reuters also reported recently that management are likely to step away from the $5bn revenue goal by 2020 for the new businesses that it set in 2017. Reuters says this number is likely to be replaced by a broader set of measures including efficiency targets and profitability metrics.
• The 3Q earnings call also contained a number of comments from management that seemed aimed at lowering expectations with lots of talk about sacrificing short term profitability for longer term paybacks:
We think about getting real contributions from some of these investments that we’re making over the next three to five years (CFO Stephen Scherr)

We continue to make investments to drive the returns of the firm higher in the medium and longer term and we are willing to sacrifice some short-term returns to make these investments, better position and strengthen the franchise and allow us to better deliver for our clients in the long run (CEO David Solomon)

Don't expect miracles
All of this suggests we need to keep focusing on the here-and-now of GS and not expect that new businesses will deliver a magic wand.

Unfortunately, the here and now continues to look very unappetizing from my point of view.

ROTE remains middling at best

The fundamental problem for GS is that it is not generating returns that are adequate for the risk profile of the business. 3Q ROTE was 9.5% and middling compared to global peers. It was the lowest of US peers, where the range was 10-13%. 9m19 ROTE is running at a slightly better level of 11% but is still probably below cost-of-equity.



Source: 10-Qs or equivalent company disclosures

GS continues to struggle against a loss of market share in its once dominant fixed income franchise where revenues are tracking almost 20% lower than 2016 levels for 9m19, the weakest relative performance of peers. Given FICC is still by far the biggest consumer of capital within GS, this explains much of the ROTE problem



Source: 10-Qs



Source: 10-Qs or equivalent company disclosures

Risk profile remains higher than peers

Yet despite poor relative profitability we know that GS continues to take more risk than peers.

Late October saw the publication of mid-cycle Dodd-Frank stress test results for the largest US banks, including GS (GS's disclosure can be found here).

Two aspects of the results stand out.

First, in the severely adverse stress scenario (which models a severe global recession and global stock market shock) GS shows the largest fall in CET1 regulatory capital of peers. The bank calculates that it would incur pre-tax losses of $33bn in the severely adverse scenario and see a decline in CET1 capital of 6.9%. This compares to an average CET1 decline of 4.2% among peers...

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