2023-06-14 19:00:18 ET
Summary
- Citi is resuming share buybacks, which should spark upside, with plans to IPO Banamex in 2025.
- The balance sheet is in good shape amid industry bankruptcies ~ Citi gained deposit share, has little HTM losses, and carries tons of high-quality liquid assets.
- This article will analyze why Citi trades at a discount to peers.
- Many analysts miss Citi's hidden moat.
- In the decade ahead, I estimate returns of 15% per annum.
A Deep Value Investment
Citigroup ( C ) is demonstrably cheap compared to the S&P 500. Over the past 10 years, the company has averaged $12.12 billion of unadjusted earnings. The stock is available for purchase at just 8x this average. It is rare for a company that has been around as long as Citi (210 years) to trade at such a low valuation. The S&P 500 trades at 30x its 10-year average earnings, inflation adjusted.
Citigroup's Net Income (Macrotrends)
The Long-term Opportunity
Citigroup's Growth
As far as growth goes, Citigroup diluted shareholders big time in 2009 in order to bailout the bank from a once-in-a-century type recession. However, even with this terrible outcome, Citi has grown its earnings per share from $1 in 1987 to $7 in 2022, a 5.7% compound annual growth rate. The company has been buying back shares aggressively since 2015:
Going forward, I think Citi will benefit from its global presence, growing alongside the thousands of businesses it serves, as well as the money supply over time. To boost growth further, Citi can repurchase shares and acquire other financial institutions at accretive prices. Thus far, I've seen wise financial decisions from Citi's board and executives. The company sold off international banks at multiples of book value and plans to use that same capital to buy back its own shares at a fraction of book value.
Citi is allowed to repurchase shares when its CET1 Ratio is above its minimum capital requirement of 12%. Currently, Citi has a CET1 ratio of 13.4% .
Banamex
Yes, the sale of Banamex fell through. Citi plans to IPO the Mexican retail bank in 2025. In the meantime, the company said it will resume "modest" share buybacks of an undetermined amount. Citi sees no effect on its medium-term targets, according to Bloomberg .
Now the disappointing part; the sale of Banamex was expected to reduce capital requirements , resulting in excess capital that can be returned to shareholders. This process may be delayed.
Citigroup's Moat
Meanwhile, Citi no doubt has a moat in its Institutional Clients Group ((ICG)) segment. The bank does business in nearly 160 countries, moving $4 trillion every single day. This global network is exceptionally difficult to replicate, and the expenses involved would be enormous. You can imagine this global network as a financial railroad, one that carries $4 trillion a day, and one that is the backbone of thousands of businesses with cross-border needs. CEO Jane Fraser said it best:
"This business is a thing of beauty. It's for 5000 multinationals; $4 trillion every single day in payroll, in cash management, in procurement, in supply chain. It's also very, very sticky."
Improving Wealth
Then of course you have Citi's credit card business in the United States, and its wealth management business. Things are looking up for Citi's global wealth unit, which recently hired Andy Sieg , 6-year President of Bank of America's Merrill Lynch. Jane Fraser said:
“Growing Wealth is a core pillar of our strategy and will improve our business mix by adding more fee-based revenue and drive improved returns.”
You can see the strategy here, Citi is moving away from risky, loan-based businesses to focus on low risk, fee-based businesses.
Taking all of this into account, I think Citigroup can compound its current earnings at 4.5% per annum over the long term.
The Balance Sheet Is Solid
Now that we understand Citi's past and its potential, let's take a look at the financial position of the company. Part of why Citi's stock is so cheap is there has been a lot of talk about uninsured deposits. This is understandable with the recent collapse of SVB and First Republic. Citigroup, not unlike these two banks, has a high degree of uninsured deposits. At year-end 2022, 85% of Citi's deposits were not insured by the FDIC. Unlike SVB, whose deposits were extremely concentrated, Citi's deposits are diversified across industries and geographies. Of Citi's massive $1.3 trillion deposit base, 47% of deposits were in offices outside the United States:
Total Deposits | $1,366 billion |
Deposits In U.S. Offices | $730 billion |
Deposits Outside U.S. Offices | $636 billion |
Source: Image created by author with data from Citi's 2022 Annual Report
Citigroup does commercial banking for businesses in nearly all industries and of nearly all sizes. These deposits are very sticky because the companies are reliant on Citi for their cross-border needs. Also, Citi has built deep relationships with its customers over the years.
Citigroup is cashed-up with ample liquidity to fund deposit withdrawals; it had a CET1 Ratio of 13.03% at year-end 2022, the second highest among its peers. Also, Citigroup had the highest percentage of high quality liquid assets in relation to deposits among the big four banks:
Unlike SVB and Bank of America (BAC), Citi has little unrealized losses on its held-to-maturity ((HTM)) bonds. The company is on par with JPMorgan Chase ( JPM ) in this regard; unrealized losses were just 17% of Citi's CET1 capital at the end of 2022. This, compared to SVB, whose unrealized losses on HTM bonds were 111% of its CET1 capital:
Citi's solid balance sheet, diversified customer base, and sticky deposits give it a lighthouse quality. It has been a beacon of safety in an industry under duress. This allowed Citi to gain deposit share against the likes of JPMorgan Chase, Bank of America, and Wells Fargo ( WFC ) over the past year:
This, despite Citi selling global retail banks, is impressive.
Citi appears to have excess liquidity. Its cash, securities, trading assets, AFS bonds, and receivables totaled $1.393 trillion (This excludes loans and HTM):
Balance Sheet Data (10Q ~ Q1 2023 )
Compared to Citi's $1.330 trillion of deposits, liquidity appears to be in abundance. If Citi begins to put its excess cash to use, profitability should improve.
Why Citi Trades At A Discount
Now, let's explore the bear thesis. Citi bears believe the company has no moat, A.K.A. durable competitive advantage. This is true when it comes to U.S. cards, U.S. retail, and U.S. investment banking. Citigroup underperformed peers on an ROA and ROE basis for years.
Return on equity, four largest U.S. banks:
However, I think bears are missing that Citigroup's moat is its ICG segment and that Citi plans to address ROE, increasing returns on tangible equity to 11-12% . On current tangible equity ($164 billion), an 11.5% return would mean net income of $18.9 billion ($9.70 per share). This would equate to an ROE of 10% on current equity.
To do this, Citi is divesting international retail banks, which have no synergies with its global network. These international banks have high costs and no moat. Divesting them should reduce Citi's capital requirements. Following this, Citi plans to curtail temporary expenses. While the postponed sale of Banamex may prolong this outcome, I think Citi will eventually get there. This is a credible and straightforward plan.
Citi also has issues with internal controls , but is addressing the issue, investing in the technology needed to make the bank more reliable. This is important when you move $4 trillion every single day. In terms of internal controls, JPMorgan Chase ((JPM)) has outperformed Citi. However, in 2022, Citi promoted former JPMorgan Chase executive Tom Anderson to the role of Chief Compliance Officer. The expenses related to this transformation should shrink in the medium term, making Citi a better, more profitable bank.
Increased regulation is a risk following the bankruptcies of SVB and First Republic. If capital requirements increased for Citi, it would put a stop to share buybacks. I do not believe banks with over $250 billion in assets need more regulation or capital; this includes JPMorgan Chase, Bank of America, and Wells Fargo, and Citigroup. Smaller banks, with $100 billion to $250 billion in assets, were excluded from Dodd-Frank regulation in 2018 as restrictions were rolled back. These are the banks that should see increased regulation, in my opinion. Many of them are not well capitalized. The "largest banks" (with over $250 billion in assets) have continued to be regulated under Dodd-Frank and are in much better shape, as we saw earlier.
Long-term Returns
In the decade ahead, I estimate compound annual returns of 15% for Citigroup ((C)):
Current EPS | $7.21 |
Current Dividend | $2.04 |
Compound Annual Growth Rate | 4.5% |
Year 10 EPS | $11.20 |
Terminal Multiple | 13x |
Year 10 Price Target | $146 |
Annualized Returns ( Dividends Reinvested ) | 15% |
Note: This is a base-case estimate.
In Conclusion
Citigroup now plans to pursue an IPO of its Mexican retail bank, Banamex, in 2025. In the meantime, the company said it will resume share buybacks and look to increase ROE. This should help close Citi's discount to tangible book, representing 70% upside over the next few years, plus dividends.
Citi's balance sheet looks very strong thanks to Dodd-Frank regulation. The company's deposits have proven sticky, and I expect this to continue. Meanwhile, bears are missing Citi's hidden moat within ICG. We continue to hold C shares, which we bought around $44 each. With buybacks now in play, I maintain a "Strong Buy" rating.
Until next time, happy investing!
For further details see:
Citigroup: Buybacks Spark Upside