2023-04-16 06:05:21 ET
Summary
- Citigroup is trading at about 59% of tangible book value per share.
- Citigroup has a normalized earnings yield of roughly 16%.
- I expect a massive stock buyback after the CCAR results, which would be enormously accretive at current levels.
Citigroup ( C ) continues to be one of the most deeply undervalued securities that I am aware of. The company has made steady progress on its goals of modernizing its technological infrastructure, divesting noncore assets, and enhancing its Services and Wealth Management Businesses. Book value per share metrics continue to grow, earnings have been solid, yet the valuation has just gotten cheaper and cheaper. Value investing is about buying securities at a large discount to intrinsic value, and Citigroup is a screaming buy at current prices.
The reasons for Citigroup’s historical discount to peers is based on the lower ROTCE it has generated, and the uncertainty that has plagued the sprawling global behemoth. Jane Fraser developed a plan to attack these issues, by divesting noncore global consumer banking operations. Many of these businesses lacked the scale to generate strong returns, and by divesting them and freeing up capital, Fraser can focus on allocating capital towards the higher returning businesses such as TTS and Wealth Management. These are less capital-intensive and have higher margin operations, that should also result in lower capital requirements as RWAs are reduced. We are still waiting for a final announcement on Citigroup’s solid Banamex franchise, on whether it will be sold or spun-off via an IPO. It feels like the bank is likely pretty far along on the sale process, but a closing is always uncertain. Ultimately a sale will have a short-term negative impact on capital upon the announcement but will be made up upon the actual sale. It also will free up billions that management can eventually use to buy back stock. There is nothing Citigroup could do right now more rewarding than buying back stock given the massive discount to tangible book value per share, but Fraser continues to bide her time, as one can under the comfort in making tens of millions of dollars in salary. I understand there are uncertainties in the near-term and that the company might want to wait for the sale announcement, CCAR, etc., but the stock would likely receive a much higher valuation if investors were confident that management would back up the truck on opportunities like this.
On April 14 th , Citigroup reported an exceptional 1 st quarter, posting net income of $4.6B and EPS of $2.19. The ROTCE was nearly 11% on $21.4B of revenues. The results were bolstered by the divestiture of the India Consumer business, which had a positive pre-tax impact of $950MM. Excluding these items, EPS was $1.86, with an ROTCE of over 9%, which is impressive given the macroenvironment. Ex-divestitures, revenues grew by 6%, as strength in Services, Fixed Income, and U.S. Personal Banking outweighed weakness in Investment Banking, Equity Markets, and Wealth Management. Expenses of $13.3B increased 1% YoY but were up 5% excluding divestitures. Citigroup is taking the painful medicine of investing in the transformation of the business to fix operational, compliance and technological issues that regulators and management have flagged as essential. The cost of credit was quite high at roughly $2B, driven by normalization in net credit losses and ACL and other provision build of approximately $700MM, due to a deterioration in macroeconomic assumptions, and growth in revolving card balances. It speaks to the earnings power for Citi’s other businesses that the company can build credit losses, while still being highly profitable.
ICG revenues were up 1% in Q1, mostly due to Services and Fixed Income. Investment Banking and Equities trading remain weak. Expenses rose by 4% driven by transformation and other business investments. Cost of credit was a $72MM benefit as an ACL release more than offset net credit losses. We saw in 2020 during the lockdowns, how well the ICG business held up in a stressed business environment, and the trading businesses tend to thrive when volatility spikes. We saw that again this quarter, with ICG producing $3.3B of net income, up 23%, and good for 13.8% ROTCE. Average loans were down 2%, while average deposits were up 3%, as the company picks up new clients. In TTS, revenues were up a stellar 31%, driven by 41% growth in net interest income. The rate environment drove about 60% of the growth this quarter, while other business developments drove the remaining 40% of growth, such as new client wins, and expansion of existing relationships. Securities Services saw 23% revenue growth. TTS and Securities are becoming a bigger portion of Citigroup’s earnings composition, and with their higher returns on equity, ultimately should help the company’s stock achieve a higher valuation. Markets revenue was down 4%, as weakness in equities more than offset the growth in fixed income, which faced a tough comp from last year. Banking revenues were down 21%, as higher rates continue to restrain client activity, but management flagged some green shoots such as improvement in investment grade debt issuance.
In PBWM, revenues were up 9% due to improvement in net interest income, but expenses were also up 9%. Cost of credit was $1.6B, driven by higher net credit losses from the normalization of Card portfolios, and a macro reserve build. Average loans increased by 7%, driven by cards, mortgages, and installment lending. Average deposits decreased by 3%, as Wealth clients put cash to work in fixed income investments mostly on the Citigroup platform. PBWM generated a subpar return of ROTCE largely due to these higher credit costs. Payment rates are declining for Cards, which has allowed 18% growth in interest earnings balances for branded cards, and 11% in retail services. Importantly, the bank produced over 13,000 Wealth referrals. Wealth revenues were down 9% however, driven by investment fee headwind and higher deposit costs, particularly in the Private Bank, where clients are quite rate sensitive. In Asia, revenues were up 20%, which is great news, as that has been a problem area for the last few quarters. Citigroup has made some key hires in Wealth Management and has been hitting well below their weight ever since the sale of Smith Barney to Morgan Stanley. There is a huge runway for growth here and if management can deliver, returns on equity should improve markedly.
Citigroup is extremely conservatively reserved for future losses with $20B in total reserves, equating to a reserve to funded loan ratio of roughly 2.7%. In U.S. Cards, the reserve is 8.1%. IN PBWM, 44% of lending exposures are in U.S. Cards where nearly 80% is to customers with FICO scores of 680 or higher. Credit remains strong historically with NCL rates still below pre-Covid levels, but they are starting to normalize. The remaining 56% of PBWM lending exposure is in wealth and predominantly consists of mortgages and margin lending. In ICG, roughly 85% of total exposure is investment grade, while internationally 90% of exposure is either investment grade or exposure to multinational clients or their subsidiary. Commercial real estate exposure across ICG and PBWM totaled $66B, of which 90% is investment grade.
Citigroup has over $1 trillion worth of available liquidity resources, including $584B of HQLA and a LCR of 120%. The company has over $1.3 trillion in deposits across its corporate and consumer banking enterprises in a multitude of regions across the globe. Citigroup’s primary institutional customers are multinational companies that are fully integrated in the bank’s payroll, supply chain, and cash/liquidity systems. These are essential tools to the everyday operational efficiency of these companies, which make the deposits quite sticky. About 35% of the balance sheet is in cash and investment securities. The bank made solid progress in Q1 in bolstering its CET1 ratio. The $4.3B of net income added 38 basis points, while the $1B in dividends reduced it by 0 basis points, and then the improvement in AOCI from declining rates drove a 7-point increase. Lastly, Consumer exits added another 4 basis points, which put the ratio at 13.4% at the end of Q1, up 40 basis points sequentially.
Citigroup’s stock rallied over 4% after reporting earnings and closed on Friday at $49.56, which is only 59% of Citi’s end of Q1 tangible book value per share of $84.21. This is simply a ridiculous valuation for a business that has normalized earnings power of over $8 per share. The normalized earnings yield is roughly 16%, which is higher than Warren Buffett received when he bought the big Japanese trading companies a few years back. Citigroup also has a variety of countercyclical businesses that can provide stability when other businesses struggle. For instance, when the economy weakens, credit losses might perk up, but the trading businesses often benefit from the volatility that can occur. Higher rates hurt the debt issuance business, but it greatly helps net interest income. Citigroup should be poised to launch a massive stock buyback upon closing the sale of Banamex and passing this year’s CCAR exam, where hopefully the bank obtains a lower requirement than last year. I believe Citigroup should trade at a minimum of $80 per share, which is just 10x a conservative estimate of normalized earnings. Accretive stock buybacks and operating leverage upon the culmination of these transformational expenses late in 2024, should ultimately lead to a stock price over $100 per share. While you are waiting, you can pocket the 4.12% dividend yield. Citigroup has been a trading stock, which should be sold at close to tangible book value per share and bought at material discounts. I think there is a brighter future than that for the bank, but the margin of safety is massive here for however one wishes to invest in it.
For further details see:
Buy Citigroup Before The Future Buybacks Raise The Valuation