CFG - Citizens Financial: Attractively Valued And Offering A Solid 6% Yield

2023-08-21 05:50:48 ET

Summary

• Citizens Financial's share price plunged year-to-date due to fears related to regional banks after several March failures.
• At the same time, CFG demonstrates solid financial performance and has made promising acquisitions in recent years.
• My valuation analysis suggests there is massive upside potential, and CFG stock also offers a 6% forward dividend yield.

Investment thesis

Regional U.S. banks' stocks suffer this year due to a sell-off started in March after the SVB bank collapse. Many banks are currently attractively traded and offer solid dividend yield, but risks for investors vary significantly among these stocks. Today I want to share my bullish opinion about Citizens Financial Group ( CFG ), which looks like a solid bet for long-term investors. My analysis suggests that CFG is a high-quality business, and the management is taking several steps to expand operations and offerings to clients. Profitability suffers a short-term drawdown, but it is also due to business growth initiatives from management. I consider current challenges for the bottom line temporary and not secular. All in all, I assign CFG a "Strong Buy" rating.

Company information

Citizens Financial Group, Inc. offers a range of retail and commercial banking products and services to individuals, small businesses, middle-market companies, large corporations, and institutions.

The bank's fiscal year ends on December 31. The business comprises two segments: Consumer banking and Commercial banking. According to the latest 10-K report, in FY 2022, Consumer Banking generated 63% of the bank's total revenue.

Financials

The bank demonstrates solid financial performance and has got a high "A-" profitability grade from Seeking Alpha Quant . Indeed, profitability metrics look strong compared to the sector median and historical performance.

Due to solid financial performance, the bank has been able to balance between being shareholder-friendly and sustaining a solid financial position. The bank consistently buys back shares and pays dividends to shareholders. In Q2 FY2023, it announced an 8% increase in the quarterly payout to $0.42 per share. The current forward dividend yield is at an attractive 6% level. In 2Q FY2023, CFG also repurchased $256 million of its stock. The balance sheet is robust with a common equity tier 1 ratio at 10.3% as of the Q2 FY2023 end, exceeding its target CET1 range of 9.5%-10.0%.

The latest quarterly earnings were released on July 19, when the bank topped consensus estimates. Revenue demonstrated a solid growth momentum with a 10% YoY increase. The net interest income [NII] 6% YoY increase was the major growth driver. The expansion of average interest-earning assets and higher interest rates propelled this growth. CFG's noninterest income marked a 2% rise from the previous year, attributed to elevated transaction volumes and reduced client hedging activities.

The upcoming quarter's earnings release is scheduled on October 18. Revenue is expected to drop by 6%, and the adjusted EPS to narrow notably, from $1.30 to $0.95.

While the bottom line faces challenges and YoY drawdown due to higher loss provisions and lower projected net interest margin, I think these are temporary and not secular. The bank demonstrates decent profitability compared to many large banks outside the "Big Four". That said, CFG is efficient and can compete with banks that have a much larger scale.

The bank's services portfolio and geographic presence are rich but have yet to expand to match market leaders. Therefore, I cannot say the bank has a wide moat in the competitive American banking industry. But, I like the steps the management took in recent years to expand the reach of its offerings, including geographic diversification. For example, in 2022, the bank completed its acquisitions of HSBC's East Coast branches and Investors Bancorp. These acquisitions expanded CFG's presence in the Northeast. In 2021, CFG acquired JMP, a capital markets firm that provides investment banking services, including strategic advisory, equity research, and sales and trading, focused primarily on the healthcare, technology, financial services, and real estate sectors. I like these acquisitions because the broader the bank's offerings will be, the bigger the competitive advantage it will build for the bank. Being perceived by the public as a "one-stop shop" for financial services provides the bank with such advantages as greater customer loyalty and lower customer acquisition costs.

Valuation

The stock declined about 30% in price year-to-date, significantly underperforming the broad market and the Financial sector ( XLF ). Seeking Alpha Quant assigned the stock a high "A" valuation grade because multiples look very attractive compared to the sector median and historical averages.

I use the dividend discount model [DDM] to proceed with my valuation analysis. Last week I analyzed the two largest U.S. banks, JPMorgan Chase (JPM) and Bank of America ( BAC ), and used an 8.5% WACC for discounting. Given CFG's smaller scale and weaker brand, I use an elevated 9.5% WACC here. I have dividend consensus estimates projecting a $1.77 payout in FY 2024. Dividend growth is always tricky, and CFG has a rather volatile history of dividend payouts, according to dividend history grade. The last five years' CAGR looks too high, and the last three years CAGR looks too low. Since we are currently in a very uncertain environment, I prefer to use a 5% dividend CAGR closer to the more conservative end of the historical range.

The DDM suggests the stock's fair value is close to $40, indicating an above 40% upside potential. CFG traded at this level at the beginning of 2023, and the stock price declined sharply after the SBV failure news and the regional bank's sell-off panic caused by it. That said, I think CFG is very attractively valued.

Risks to consider

As a bank, CFG faces substantial macroeconomic risks. Unfavorable macroeconomic risks adversely affect the credit quality of borrowers. During economic downturns and high-inflation environments, borrowers are highly likely to face financial difficulties, leading to higher loan default rates. This will adversely affect the quality of CFG's loan portfolio and increase its loan loss provisions.

Being less diversified than the largest U.S. banks mean that CFG's earnings are more vulnerable to interest rate fluctuations. As interest rates move, CFG's borrowing and lending costs are affected. While a bank's margins tend to be stable over the long term, adverse short-term fluctuations in earnings are likely to change interest rates.

The current market sentiment regarding regional banks looks pessimistic after the SVB failure in March 2023 and the recent credit ratings downgrade for several regional banks from Moody's. While CFG's credit rating did not suffer, Moody's shifted the outlook of CFG to "Negative." While my analysis suggests the bank's financial performance and position are solid, I consider the credit rating downgrade for CFG as low. But, the negative outlook from Moody's could weigh on the stock price in the near term.

Bottom line

To conclude, CFG is a "Strong Buy". While the bank currently faces challenges for the bottom line, they are temporary. The bank continues to demonstrate solid revenue growth and is expanding its business via acquisitions which I believe will add value. This year's weakness for regional banks' stocks provides investors an excellent entry point opportunity and a solid dividend yield. I believe that these potential benefits outweigh all the risks and uncertainties.

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