Contents
Summary
- GS is currently attractively valued but there is the $7.5B overhang the Malaysian government is seeking to recover from GS.
- Priorities are to focus on investments for growth, improve operating efficiency, and to enhance the durability of revenues and earnings.
- GS continues to shift its funding mix from unsecured long-term debt to deposits. The benefits of this shift are increased funding diversification, lower financing costs, and a capacity to increase business in GS’s bank subsidiaries.
Introduction
My experience as a very new Goldman Sachs (GS) shareholder (GS’s share price has certainly been volatile subsequent to me taking a position in November) reinforces my opinion that investing in high quality companies for the long-term is the appropriate route to follow.
In my November 18th article I indicated that based on my analysis I would be initiating a position in GS within the next 72 hours. In keeping with my full disclosure I acquired 150 shares on November 21st for the ‘side accounts’ within the FFJ Portfolio.
Following this purchase what did GS’s share price proceed to do? It got caught up in the December market swoon and dipped as low as ~$151 by mid-December; the share price has subsequently recovered to the current ~$199 level.
In my previous GS article I touched upon the extent to which Berkshire Hathaway (BRK.a and BRK.b) had increased its exposure to GS; the September 30, 2018 Form 13F is the most current available.
In hindsight I should have acquired more GS shares in December but I chose to deploy funds in other high quality companies; articles regarding investments I made in other companies can be found here.
Malaysia's 1MDB corruption scandal
In my November 18th article I touched upon this well publicized scandal.
There is no denying that the Malaysian 1MDB corruption scandal (the government of Malaysia is seeking $7.5B from GS) is a dark cloud overhanging GS which explains why GS is so attractively valued.
Further high level information can be found here and a CNN interview with Malaysia’s Finance Minister can be found here.
On the January 16th GS earnings call GS provided additional information on this matter.
GS is cooperating with the Department of Justice and other regulators but since this is still an open investigation GS must be careful with what information it disseminates.
GS acknowledges that the people of Malaysia were defrauded by many individuals, including the highest members of the prior government. In addition, one of GS’s former partners has, by his own admission, admitted guilt.
GS continues to investigate whether there is anything that GS could have done better even though before each transaction a considerable level of due diligence is conducted. In the case of the Malaysian transaction, GS inquired whether any intermediaries were involved and GS’s former partner said no intermediaries were involved in the transaction. As detailed in the government's charging documents, GS’s former partner purposely concealed from GS his scheme with Malaysian government officials, IPIC officials, 1MDB and Jho Low.
As part of GS’s due diligence efforts at the time, it sought and received written assurances from both 1MDB and IPIC that no intermediaries were involved in the first 2 transactions. In the final offering, the government of Malaysia itself and 1MDB represented that no intermediaries were involved in the offering. All these representations to GS have proven to be false. Also during this period, 1MDB's outside auditors with access to the books and records issued clean audit opinions.
With respect to Jho Low, GS declined Jho Low's request to open a private wealth account in 2010 because it could not verify the source of his wealth. Out of prudence, it also declined to advise or represent Low on other opportunities he presented to GS in 2011 - 2014.
While the Malaysian government is seeking $7.5B from GS, I strongly suspect this case will be tied up in the legal system for a few years. I am also of the opinion that the both parties will settle for an amount far less than $7.5B.
I strongly suspect GS may be at fault to some extent on this transaction but I think the Malaysian government bears some of the responsibility given that its Prime Minister placed his trust in this Jho Low individual who had just graduated from college. Clearly, GS is not solely responsible for the disappearance of several billion dollars!
I recommend you review the ‘Overview of Goldman Sachs’ document found on GS’s website.
January 16, 2018 Q4 and FY2018 Earnings Conference Call
On GS’s recent conference call in which Q4 and FY2018 results were discussed GS’s new CEO indicated that a comprehensive review across each of GS’s businesses, including 3-year forward plans to identify opportunities to strengthen or expand the client footprint and to operate more efficiently is currently being conducted at the most senior level. Included in these strategy sessions are discussions on how to deepen existing relationships and expand the client footprint by developing new products and business platforms.
Source: GS - Q4 and FY2018 Results Presentation
GS’s CEO indicated that while GS has a leading institutional market-making fixed income currencies and commodities (FICC) franchise there has been a reduction in the industry wallet over the past decade. In order to address this, GS has over recent years improved its capital utilization and has reallocated capital away from FICC in order to grow strategically its more important and higher returning businesses. The plan is to continue to optimize capital and to further reduce expenses through automation.
Having one of the most unique sourcing platforms given GS’s global footprint, the plan is to partner with clients to invest their capital alongside GS’s own capital. Based on GS’s track record it is felt that there is an opportunity to raise additional 3rd party funds across equity, credit and real estate, thereby augmenting fee income. Simultaneously, this would enhance GS’s ability to continue to monetize on-balance sheet investments and optimize capital consumption.
GS has identified cash management as an attractive growth area given the breadth of its corporate relationships and the size of that wallet. GS is now 6 months into a 2-year build and it intends to use this cash management platform for its purposes later in 2019. By using this new platform for internal purposes, GS will be able to validate the product while reducing costs and operational risk. If all goes as planned, GS expects to launch the product to clients in 2020.
In addition to the above noted initiatives, GS now serves 3 million customers through its lending and savings products in Clarity Money. The plan is to further enhance the platform to include a multi-tiered mass affluent digital wealth offering; this is currently in development.
Senior management is reviewing strategic priorities with the Board. The priorities focus on investments for growth, improvements in operating efficiency, and a commitment to enhance the durability of revenues and earnings. The plan is to communicate a more comprehensive update and to share specific metrics and financial targets to the investment community in the coming months.
GS’s CEO pointed out on the conference call that there has been quite a disconnect between the weak market sentiment and the optimism it continues to see in corporate board rooms. In Q4, and in December in particular, investor sentiment declined with respect to the global growth outlook. This has created challenges for many of GS’s institutional investing clients but it is also driving potential future opportunities for active managers to add value.
Q4 and FY2018 Results
I provide links to GS’s Q4 and FY2018 Earnings Results and the Q4 and FY2018 Results Presentation for quick access.
Source: GS - Q4 and FY2018 Earnings Results
In a nutshell, GS reported full year net revenues of $36.6B, its highest level in 8 years. It delivered a return on equity of 13.3% and return on tangible equity of 14.1%. Most importantly, GS is making significant investments to further expand its client franchise, grow revenues and enhance the long-term earnings profile of the firm, the cost of which is being funded by the embedded operating leverage in its businesses.
GS continues to shift its funding mix from unsecured long-term debt to deposits. In its consumer deposits business, GS raised over $35B.
The rationale for shifting to consumer deposits is that GS benefits from increased funding diversification, lower financing costs, and a capacity to increase business in its bank subsidiaries.
Credit Ratings
A comprehensive recap of ALL of GS’s credit ratings, including those of its affiliates can be found here; the credit ratings that are most relevant for my purposes are those for GS Group Inc..
All long-term credit ratings for that entity are satisfactory for my purposes.
Dividend, Dividend Yield, and Dividend Payout Ratio
GS paid out approximately $1.2B of common dividends over the course of the year.
Please refer to my November 18th article for further details.
During the course of FY2018, GS repurchased 13.9 million shares of common stock for a total of $3.29B. These repurchases contributed to a reduction in basic share count of 8 million shares for the year.
As at the end of FY2018, the weighted average number of diluted shares outstanding has been reduced to 390.2 million (for the 3 months ending December 31, 2018 – page 13 of 18). NOTE: This figure could increase by just shy of 8 million (looking at the amounts in recent years) due to restricted stock units and stock options. As at the time of the article only the Form 8-K is available and it does not include restricted stock units and stock options detail.
Valuation
In my November 18th article I projected that GS would generate diluted EPS of ~$25.61 for FY2018. Now that GS has released its FY2018 results we see that basic diluted EPS amounted to $25.53 and adjusted diluted EPS amounted to $25.27.
With GS having closed at $199.09 on January 17th we get an adjusted PE of ~7.8 and an adjusted diluted PE of ~7.88.
GS does not provided earnings guidance but the current mean adjusted EPS estimate for FY2019 from 25 brokers is $24.39. Using this estimate and the current $199.09 stock price we get a forward adjusted PE of ~8.16. This is not much different from the forward PE of ~7.9 as at the time of my November 18th article.
Final Thoughts
I purchased GS shares in November at roughly the same value as the current stock price and knowing full well that the courts could find in favor of the Malaysian government which is seeking $7.5B from GS.
In my opinion I do not expect this case to be resolved in the short-term and I also think the courts will find that the Malaysian government bears some responsibility for the loss it incurred. As a result, I think GS will need to make restitution for an amount far less than $7.5B.
GS, in my opinion, is currently attractively valued and represents a worthwhile long-term investment.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long GS.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
