Goldman Sachs Earnings Preview: 20% Undervalued Thanks Primarily To The Absence Of The Share Buyback (NYSE:GS)

It didn’t really help that the last few weeks my bedtime reading at night was the “Billion Dollar Whale”, the story of the now-infamous Malaysian Jho Low and the pilfering of the 1MDB Malaysian sovereign debt fund, where Low basically spent $12 billion of the fund’s proceeds on everything from excessive partying, to artwork, to real estate, to yachts, to you name it, some of the debt issuance aided by the most respected of all former white-shoe firms, Goldman Sachs (GS).

Gary Cohn and Lloyd Blankfein aren’t exactly portrayed in a favorable light at the end of the book, particularly after the posturing post-2008, but all that being said, the issue is behind Goldman and it’s not worthy of further discussion.

Goldman reports its Q3 ’20 financial results on Wednesday, October 14th, before the opening bell, with current Street consensus per IBES by Refinitiv, expecting $5.22 in EPS on $9.25 billion in revenue for expected y/y growth of 9% and 11% respectively.

It was a monster second quarter that Goldman reported in mid-July ’20, when the investment banking giant printed $6.26 in earnings per share versus a $3.13 estimate on revenue of $13.3 billion versus the IBES/Refinitiv estimate of $9.76 billion for upside surprises of 100% and 36% respectively.

Goldman’s net revenue grew 41% y/y in Q2 ’20, generating 8% EPS growth, also y/y.

Q2 ’20 results were emblematic of the late 1990s’/early 2000s’ monster quarters the investment banks printed in robust markets.

Fixed-income revenue was 120% higher y/y while equity revenue was 60% higher, with fixed income primarily driven by the explosion in corporate bond issuance after Jay Powell lit the lamp in late March/early April ’20 announcing the various Fed liquidity programs.

Buyback Impact

GS Share Buyback Impact

Source: Internal valuation s/sheet from earnings releases, 10-Qs

When looking at current forward estimates for Goldman, the current 2022 estimate is $26.57 (that estimate has been moving higher since the summer), which given a reasonable 10x multiple would put a reasonable valuation of $265 on the stock.

The stock’s high in 2020 was in $250.46 on January 22, 2020, thus I don’t see any reason that the stock can’t trade up there again given the trend in estimates for 2021 and 2022.

However, for companies owned for clients, a lot of fundamental valuation is done on the holdings, and the above Excel spreadsheet shows that – for any given quarter in the last five years – the “trailing twelve-month” share repurchases have amounted to anywhere from 4% to 10% of the market cap for any given quarter.

And now, that buyback is temporarily (hopefully) suspended.

Source: JPMorgan’s “Guide to the Markets” October 2nd, 2020

Looking at the right chart of the two posted above from JPMorgan’s (NYSE:JPM) Guide to the Markets this quarter, readers can see how the “buyback yield” is greatest for the Financial sector of all 11 S&P 500 sectors.

That is a powerful EPS catalyst that is temporarily gone.

Corporate debt issuance as of YTD Q3 ’20 was close to $1.5 trillion (which I was hoping to confirm with Schwab’s fixed-income trading desk but couldn’t) which is clearly a record. That includes all debt, not just corporate high grade and high yield. Fitch, the respected credit rating agency, published some debt issuance data in June ’20 and noted that at that time, 2020’s run rate of $584 billion in investment-grade debt would surely top the 2017 record of $644 billion.

The emergence of SPACs and their impact on IPOs is one thing I’ve wondered about over the summer as the SPAC became a very easy way to bring companies public (as I understand it) without the benefit of an underwriter’s experience like a Goldman Sachs or a Morgan Stanley (NYSE:MS).

Palantir’s )PLTR_ IPO was “direct” which also eliminated the underwriter.

The question I had is whether this is now a permanent “disruption” of the investment banking-led IPO, where the analyst of the bank had input on valuation.

Looking at Goldman’s Changing EPS and Revenue estimates:

Q3 ’20 est Q2 ’20 Q1 ’20 Q4 ’19
2022 est EPS $26.54 $25.07 $24.71 $28.93
2021 est EPS $22.73 $22.61 $21.62 $27.40
2020 est EPS $13.79 $17.71 $13.70 $24.58
2022 est EPS gro 17% 11% 14% 6%
2021 est EPS gro 65% 28% 58% 11%
2020 est EPS gro -34% -16% -35% 17%
2022 PE 8x 8x 7x 7x
2021 PE 9x 9x 8x 8x
2020 PE 15x 11x 13x 9x
2022 est rev($’s bl’s) $38.5 $37.6 $36.8 $38.7
2021 est rev $37.6 $37.3 $36.1 $38.0
2020 est rev $40.1 $39.3 $33.6 $37.0
2022 est rev gro 2% 1% 2% 2%
2021 est rev gro -6% -5% 7% 3%
2020 est rev gro 9% 8% -8% 1%

Estimate Source: IBES data by Refinitiv as of 10/6/2020

Asset-management: With Charles Schwab (NYSE:SCHW) and Ameritrade (NASDAQ:AMTD) joining forces and Morgan Stanley buying E-Trade (which already looks like a smart move for Morgan), Goldman bought Folio this summer, which appears to be its response to the third-party RIA custodian market; however, given Goldman’s reputation and dominance in banking and trading, I’ve wondered if it’s overlooked the potential growth in asset management for too long, and lost its chance to be a dominant player.

I have to hand it to Charles Schwab, as soon as the 2000-2002 recession hit, Chuck pivoted towards targeting growth in assets under management and pivoted away from trading. Schwab was never a big proprietary trader like Goldman was, so post-2008, it didn’t have to shed that business, but – again – I wonder if Goldman waited too long to target the RIA custody space.

Summary/conclusion: When looking over the EPS and revenue consensus for any earnings preview being written on Seeking Alpha, the first thing looked for is the direction of the EPS estimates, and for Goldman Sachs, the numbers have been revised upward since the last earnings report in mid-July ’20.

The stock is cheap on PE and price-to-book bases, but as the article examines, the buyback suspension has definitely postponed a powerful EPS catalyst for the banking giant.

The longer picture is more clouded as the white-shoe firms of the ’80s, ’90s and ’00s have now given way to the RIA giants like a Schwab, BlackRock and the third-party custodial market. It worried me that in the second quarter of 2020 with revenue up 41% y/y, EPS growth was only 9%, obviously hindered by no buyback. But that also means Goldman is a little fat in the middle in terms of expenses.

Goldman was late to that market (third party), but with Folio, it has an entry; it just seems unclear on what kind of priority is being placed on the business.

Within the last few days of the third-quarter ’20, the Federal Reserve said it was continuing to prohibit share repurchases through the fourth quarter of 2020.

Clients have a 1.5% position in Goldman (it is not one of our top 3-4 financial sector holdings) with an average cost basis near $210. At the time the Bank ETF (XLF) was swapped for GS, with the thinking that capital market activity would drive greater EPS growth than the pressure the banks were seeing, and while we could argue that was the case, GS stock has remained mired in the low $200s.

It might take until 2021 for Goldman’s valuation to be realized. The first stop is likely book value in the high $220s and then ultimately I do think the stock trades to Jan ’20 high of $250.

Disclosure: I am/we are long GS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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