Deutsche Bank Sees 40% Upside for Goldman Sachs (Update 3)

Updated with a differing opinion on Morgan Stanley from UBS analyst Brennan Hawken, ratings downgrades from Moody's Investor Service, reaction from Morgan Stanley and aftermarket reaction from investors.

NEW YORK (TheStreet) -- Large brokers are facing a very difficult operating environment, with weak investment banking and trading revenues, but Deutsche Bank analyst Michael Carrier sees 40% upside for shares of Goldman Sachs (GS).

Carrier late on Wednesday cut his second-quarter earnings estimate for Goldman to $1.05 a share from $2.25, while raising his operating EPS estimate for Morgan Stanley (MS) -- netting out an estimated debit valuation adjustment of $800 million -- to 58 cents from 42 cents.

The analyst said that "in terms of the stocks, the brokers have fallen back towards 2H11 lows, & while macro risks remain, given attractive valuations & eventual political/macro progress, we view the risk/reward as more attractive & prefer GS."

Deutsche Bank is expecting the brokers' second-quarter trading revenues to decline 20% from the fourth quarter "given the tough macro backdrop, with seasonal weakness in debt underwriting (DCM) & macro weakness in equity underwriting (ECM), while M&A should be higher off of low levels," and Carrier said that with a "decent pipeline" of deal activity, investment banking "should have legs if/when trends improve."

Carrier expects the brokers to "focus on cost structures and potentially accelerate cost-cutting initiatives," but also believes investors will see "some pickup in capital deployment" through share buybacks or dividend increases, "though the macro backdrop will likely limit significant moves." The analyst expects Morgan Stanley to move forward with its purchase of an additional 14% of the Morgan Stanley Smith Barney (MSSB) joint venture from Citigroup (C), and for Goldman Sachs "to modestly increase buybacks."

Goldman's shares closed at $96.55 Wednesday, returning 8% year-to-date, following a 46% decline during 2011.

The shares trade for 0.8 times their reported March 31 tangible book value of $123.94, and for 7.5 times the consensus 2013 EPS estimate of $12.93, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $11.35.

Carrier on Wednesday reiterated his "Buy" rating for Goldman Sachs while lowering his price target for the shares to $135 from $145, and cutting his 2012 EPS estimate to $10.25 from $11.50, and his 2013 estimate to $13.00 from $13.75. Deutsche Bank's price target for Goldman is roughly the firm's forward tangible book value estimate "above peers given its premium [return on tangible equity], but below historical levels given macro & regulatory risk."

That's 40% upside for Goldman's from Wednesday's close, based on what Carrier calls the company's "strong relative positioning, its solid risk management, and its attractive valuation."

The analyst expects Goldman "to post a weak quarter in 2Q (EPS of $1.05, versus consensus at $2.05), driven by a weaker trading and investment banking environment (due to a weaker macro backdrop, lower markets/wider spreads, & seasonality) and pressure in investing & lending and investment management (due to lower markets/wider spreads).

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