C - Citigroup: What To Expect In 2024 And 2 Key Catalysts

2024-01-07 22:29:42 ET

Summary

• Citigroup's stock is undervalued, with a huge disconnect between market valuation and company guidance.
• Sentiments on the institutional side are beginning to change, with bullish views on C stock emerging.
• Near-term catalysts include Q4-2023 earnings and the Fed's release of the annual CCAR stress tests in June 2024.

My recent Citigroup (C) article described it as an asymmetric risk-rewards opportunity. The stock was trading at less than 0.6x tangible book value ("TBV") which indicates that Mr. Market was assuming a return on tangible common equity ("RoTCE") at around mid-single-digit.

Whereas the management team is guiding for 11% to 12% RoTCE in the 2025-2026 period. There remains a huge disconnect between what the market valuation is implying and the guidance by the company. This has to converge in the next 12 to 18 months one way or another.

My considered view has been that the company has a credible path to meet its guidance of 11% to 12% RoTCE. This entails revenue CAGR of 4% to 5%, strict cost management, and capital optimization. I postulated that even if came short of reaching its guidance fully, Citi should be able to achieve at least 10% RoTCE and TBV of $100 by the end of 2025. This should translate to an $80 to $100 share price.

My conviction in this idea has been high (as reflected in my X account ) and I executed it utilizing long-term call options.

Fortunately, sentiments are beginning to change now and the share price has climbed strongly in the last 2 months or so:

I sense that the sentiments on the institutional side are beginning to evolve and new believers are beginning to express bullish views on Citigroup's stock. The most recent upgrade has been by Wells Fargo Securities analyst Mike Mayo who upgraded Citi to outperform with a 12-month price target of $70 and a 3-year target of $119. In this Bloomberg interview , Mike Mayo noted that his top 3 picks in banks are "Citigroup, Citigroup, and Citigroup".

Citigroup's restructuring under Jane Fraser is already in its third year. 2024 is the beginning of the "money time" and the management team needs to demonstrate solid proof points to retain any sort of credibility. Mr. Market is watching quite carefully and thus investors should expect heightened share price volatility potentially both ways to the upside and downside.

There are two near-term catalysts that investors also need to be cognizant of:

1. Q4-2023 earnings where the management team is going to be providing key information to the market including detailed cost guidance.
2. June 2024. This is when the Fed releases the results of the annual CCAR stress tests.

What to expect in next week's earnings release?

Firstly, Citi is going to be providing separate financials (including ROE) for each of its key divisions, namely, (1) Services (2) Markets (3) Investment Banking (4) U.S. Personal Banking, and (5) Global Wealth Management.

The Services division has been the star performer recently and is often been described as the crown jewel of Citi. I expect management to show that it delivers ROE in and around the 30% mark which is exceptional returns for what is a low-risk business. Services delivered year-on-year 18% revenue growth (Q3 year-to-date) but approximately half of that growth is attributed to higher interest rates. Given that we are probably at peak rates, I expect Citi to guide us to "only" mid to high single-digit revenue growth in 2024 and beyond.

I estimate that the Markets division will likely show a lowish ROE in the range of 9% to 10%. This is predominantly due to crippling regulatory capital rules affecting this line of business introduced in the wake of the global financial crisis. The story for Markets is likely to be all about capital optimization as opposed to revenue growth and I expect Citi to target low to mid-teen ROE in this division in upcoming years.

The Investment Banking division is going through a cyclical downturn predominantly triggered by the rapid rise of interest rates that affected M&A advisory mandates, debt, and equity issuances. In a normal environment, I would expect Citi to deliver mid-teens ROE in this business and expect Citi to guide to some recovery in 2024 as interest rates have likely peaked and are expected to decline from here.

I expect U.S. personal banking to continue to benefit from Cards' outstanding loan balance growth and to show mid to high-teens ROE. Whereas the Global Wealth Management division has disappointed in its lackluster revenue growth print in recent years. Citi would likely guide to ROE in the high teens or low 20s and highlight the growth opportunities seen by its well-regarded new head of Global Wealth Management Andrew Seig.

The Fed Stress Tests ("CCAR")

Citi did not perform well in the last 2 CCAR tests which manifested in higher capital requirements for the firm and currently, Citi is subject to a high CET1 target of 13.3% which hurts its reported ROTCE percentage.

I expect this to begin to turn in 2024 and beyond for several reasons. Firstly, the disposal of Global Consumer Bank franchises should reduce the forecasted stressed losses under CCAR. Secondly, the resurgence of revenue growth in Services and lower risk profit mix of Citi should materially help its performance under the upcoming 2024 CCAR test.

This is currently not factored in by the market. Citi, on its part, is assuming higher capital requirements going forward, including the unmitigated impact of the Basel III reform, in its guidance for the 11% to 12% ROTCE target. In short, the Fed's CCAR test could turn into an exceptionally positive tailwind for Citi and is due to be released in June 2024. So do watch this space as it will be key for any increased share buybacks in 2024.

Final Thoughts

The strategic transformation of Citi by Jane Fraser is not cosmetic. This is the deepest restructure of Citi in decades and it makes a lot of strategic sense as well. Citi is becoming simpler and smaller which should translate into an easier bank to manage and overall lower capital requirements. I also have very little doubt that Citi finally has the political willingness and ability to also deal with its cost structure. I believe it is only a matter of time before the market begins to recognize that this is a genuinely successful turnaround.

My expectations remain more conservative than management's guidance and thus far less heroic. I expect Citi to only deliver 10% RoTCE by 2025/2026 which translates to a share price of $80 to $100.

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