Analysis: GS

On Tuesday, before the opening bell, Goldman Sachs (GS) reported a top- and bottom-line beat with its second quarter results. On the top line, revenue of $9.46 billion (-2% YoY) exceeded the consensus of $8.839 billion, and earnings per share of $5.81 (-3% YoY) smashed the consensus of $4.89.

In addition to the solid heading readings, the bank's annualized return on average common shareholders' equity (ROE) was 11.1% in the quarter, the same as in the first quarter. Annualized return on tangible equity (ROTE) in the quarter was 11.7%, also the same as in the first quarter. That ROE number is much better than the approximately 9.5% estimates we saw into the print.

Furthermore, book value per share (BVPS) came in at $214.10 (+2.5% QoQ), while tangible book value per share (TBVPS) increased to $203.05 (+2.4% QoQ).

Remember, we see return on tangible equity as a key driver behind the price-to-tangible book value multiple as the greater and more consistently the firm can generate a return on its tangible equity or book value, the more that equity or book value is ultimately worth to us as investors. We note that at its current price, GS trades roughly at 1.05x tangible book.

Additionally, speaking to the bank's financial standing, the firm's common equity tier 1 (CET1) ratio, which compares core equity capital to total risk-weighted assets and is a measure of financial strength, came in at 13.8% (+10 bps YoY).

On the capital return front, the bank repurchased $1.25 billion of common shares in the quarter and paid out approximately $319 million in dividends. As a reminder, Goldman's capital return program became much more shareholder friendly following this year's Comprehensive Capital Analysis and Review -- or "stress test" --  which the bank passed with flying colors, unlike last year. That performance also allowed the firm to announce a 47% increase to the quarterly dividend and a $7 billion buyback program that will be implemented over the next four quarters that you can read about in our Alert here.

Investment Banking

Digging into the individual operating segments, you'll find that, starting with investment banking, revenues of $1.86 billion (-9% YoY) exceeded consensus of $1.767 billion. Making up the segment's top line were Financial Advisory net revenues of $776 million (-3% YoY) which was in line with expectations. Although revenues here was a year over year decline, it's worth mentioning that 2Q2019 year to date net revenues are up 20% YoY, a reflection of Goldman's leading market share and strong M&A volumes.

Total Underwriting revenues $1.087 billion (-12% YoY) can be split into Equity ($482 million, down 1% YoY) and Debt ($605 million, down 19% YoY). On the equity side, management cited the massive 78% sequential improvement to the government shutdown that impacted the first quarter, while revenues remained flat on a year over year basis. In debt, management attributed the weak year over year figures to the number of deals that occurred last year that did not repeat to the same extent this year. Overall, management said the Investment Banking backlog has decreased slightly quarter over quarter, however, the backlog for both advisory and debt underwriting increased sequentially.

Institutional Client Services

Moving to Institutional Client Services, revenues of $3.48 billion (-9% YoY) also beat expectations of $3.331 billion. On FICC, or Fixed Income, Currency and Commodities, sales of $1.469 billion missed consensus of $1.521 billion as revenues fell 13% YoY and 20% sequentially, reflecting a challenged environment characterized by low volatility and low client activity, though management did notice improvements in FI later in the quarter.

On the Equities side, revenues of $2.01 billion exceeded consensus of $1.797 billion as revenues impressively grew 6% YoY and 14% sequentially. Notable strength came from equities client execution (+12% YoY) and securities services (+5% YoY), while commissions and fees increased 2% YoY. As a whole, management believes the success in the quarter reflects its further consolidation of global market share and full suite of services.

Investment & Lending

At Investment & Lending, revenues of $2.53 billion (+16% YoY) topped expectations of $1.997 billion. At Equity Securities, revenue increased 20% YoY to $1.54 billion and was primarily driven by revaluations that occurred from a hot IPO season, including ~$500 million in net gains from investments that went public during the quarter. On the Debt securities and loans side, sales of $989 million included $872 million of net interest income and modest mark-to-market gains.

Investment Management

Finally, within Investment Management, revenues of $1.59 billion (+16% YoY) was shy of the $1.678 billion expectation. Management and other fees saw solid YoY revenue growth (+4% YoY) to $1.395 billion, which reflected continued growth in assets under supervisions, while Inventive fees plummeted 86% YoY to $44 million due to timing realizations in 2018. Transaction revenues also fell 16% YoY to $153 million due to lower transaction revenues from Private Wealth Management client trading activity.


On the expense front, the bank's year-to-date efficiency ratio (operating expenses/revenue) declined YoY to 64.7%, but the year-to-date figure stands at 65.6%, which is up 1% YoY due to lower revenues and ongoing investments, partially offset by lower compensation expense.

On the topic of ongoing investments, perhaps the two most notable investments of Goldman Sachs right now are with Marcus and the Apple Card Portfolio. During the conference call, management said that its year to date total pretax cost for these two initiatives, plus a new transaction banking platform, totals $275 million which has dragged down ROE by about 60 basis points. Although these initiatives a currently running at a loss (and our embedded into current performance), management believes that the drag will reverse to an accretive contributor to the firm's ROE as they scale. The Apple Card is still expected to launch later this summer, and management plans to provide more specific numbers around this initiative once it launches and builds out.

Bottom Line: We liked the quarter from Goldman Sachs as it was near clean sweep of better than expected results across its main business segments with solid increases to tangible book value, a factor that a bank's stock price should theoretically move in the same direction of. We also must say it is very refreshing to not have management's earnings call bogged down by 1Malaysia Development Berhad scandal litigation, which was a theme in 2018 and prevented the stock from ever sustaining a rally, as instead management was able to focus on its consumer-related initiatives (Marcus and Apple Card) and its strategic decisions within the wealth management business. Lastly, we appreciate Goldman Sachs newfound ability to boost its shareholder returns. Not only does the 47% dividend hike put the yield firmly above 2%, CEO David Solomon said this decision was based on confidence in the "increasing durability and profile of the revenues of the firm." Plus, the $7 billion buyback represents about 9% of the firm's market cap. We reiterate our One rating.