2023-06-17 08:00:00 ET
Summary
- Citigroup stock is still undervalued relative to its financial sector peers. It underperformed its peers for many years. However, I gleaned that the tide is potentially turning.
- The bank has made plans for life after the Fed's unprecedented rate hikes, which could see more pressure over its NII growth. However, its astute positioning should mitigate the headwinds.
- Moreover, analysts have already penciled in QoQ declines in revenue before reversing in Q1'24.
- Buyers have consistently defended Citi's steep pullbacks since it bottomed out in October 2022, suggesting a significant improvement in buying sentiment.
- I assessed that investors with no or little exposure in Citi should take the opportunity to add positions before it leaves them behind.
Citigroup Inc. (C) will head into its second-quarter earnings release in July from a position of strength as dip buyers returned to bolster its buying sentiments after it underperformed its Financial sector (XLF) peers in May.
Citi remains significantly undervalued relative to its sector peers. Seeking Alpha's Quant rated Citi's valuation with a "B+" grade, highlighting its appeal. I also assessed that buyers had returned robustly to support Citi at significant dips since its October 2022 lows, suggesting they aren't expecting things to get worse from here.
As such, I believe Citigroup investors should be assured that market sentiments have improved significantly as CEO Jane Fraser and her team execute the bank's ambitious transformation plans. The recent banking crisis has also corroborated investor confidence, as Citi could leverage the fallout over the regional banks to bolster its position further.
Notwithstanding, Citi's valuation drivers are predicated mainly on the strength of its Institutional Clients Group or ICG. Trefis' sum-of-the-parts or SOTP valuation framework estimates that ICG accounts for more than 80% of its valuation.
However, CFO Mark Mason commented at a conference this week that the bank sees its markets revenue falling by 20%, impacted markedly by the 25% decline in equities revenue. However, investors didn't react negatively, as Citi stayed well above its lows in late May.
Furthermore, Mason reminded investors that the bank is preparing for life after the Fed's rapid rate hikes, as it reduced its "asset sensitivity position, anticipating potential rate decreases in the future." As such, I assessed that investors must be prepared for a lower NII growth environment moving ahead as the Fed nears the end of its rate hikes.
Fed Chair Jerome Powell didn't preclude the possibility of further rate hikes, as the FOMC's median terminal rate increased to 5.6% in its revised projections. However, even if the Fed raised interest rates by another round or two, we are still at the end of the current program. Hence, I'm assured that Citigroup management has prudently configured the bank's strategy for lower rates moving forward.
Despite that, Citigroup remains confident of achieving FY23 revenue of "around $78 billion to $79 billion, excluding the impact of divestitures." Analysts' estimates suggest that Citigroup could exceed Mason's guidance, with Q2's $19.9B potentially marking the upward inflection in its YoY growth cadence. Despite that, analysts have already penciled in QoQ declines in revenue through FQ4'23 before reversing in Q1'24.
As such, I assessed that the market has already priced in these headwinds as Citigroup works toward its medium-term RoTCE target of 11% to 12%. Notwithstanding, it wouldn't be a simple task, given the NII growth headwinds moving ahead, requiring Citigroup to work harder on "bending the cost curve" while requiring "revenue momentum," among other challenges.
C/XLF price chart (weekly) (TradingView)
From C/XLF's price chart, investors can glean that buying sentiment has improved markedly from the lows in December 2022. As such, it has helped Citi outperform its XLF peers since then, including the banking crisis in March.
Also, the long-term underperformance of C/XLF could be overturned, as the long-term downtrend of C/XLF has reversed, forming a pivotal golden cross in late May.
Notwithstanding, the current price structure suggests that a pullback in C/XLF is looking increasingly likely. However, I assessed that further rotation into Citi relative to its XLF peers seems to be forming, which could attract more value-conscious investors to Citi.
The subsequent pullback from its recent highs will likely determine whether this thesis could work out, but the risk/reward upside looks constructive from a price action and valuation perspective.
Rating: Maintain Buy.
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing, unless otherwise specified.
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Citigroup: Buy This Bargain Before It's Gone