Goldman Sachs (GS) has made substantial progress with its deleveraging and has allayed liquidity concerns, says FBR analyst Steve Stelmach.
The result is that the bank is set to enjoy higher risk premiums and increased market share during this period of distress for its rivals.
Granted, the market already seems to be anticipating much of this. At $111, the stock has rebounded nicely from its lows around $50, as it actually started heading up well before the big financial rally of the last few weeks.
Here’s their summary:
• Takeaways. Goldman Sachs is operating in a weakening economy with long-term
hurdles for capital markets–intensive businesses. We believe, however, that the market
disruptions provide significant opportunities in the form of higher risk premiums (higher
returns relative to associated risks) and increased market share in what we expect will be
a difficult investment banking environment. We do not expect the company to achieve
management’s targeted 20% returns on equity (ROEs), but we believe that mid-teens
returns are attainable. We also believe that investors will take comfort in this less levered
institution that has already recognised a significant portion of credit-related write-downs.
• Value add. We expect Goldman Sachs to lose roughly 100 bps of ROE for every turn of
leverage coming off the balance sheet. Contrary to management’s opinion, we believe
that higher leverage has definitely helped the company to generate significant returns on
equity. With leverage significantly reduced (and still declining, in our opinion), we
believe that Goldman can sustain ROEs between 13% and 15%, rather than the 20%-plus
levels of the past decade.
• Valuation. GS currently trades at 1.28x tangible book value (TBV) of $88.00 and at
10.22x our 2010 EPS estimate of $11.05. Based on our current outlook for returns on
equity in the mid-teens, we believe that a valuation closer to 1.5x tangible book is
appropriate for a return on investment of 10%.
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