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."