2023-04-10 09:00:26 ET
Summary
- Citigroup Inc. is set to release its Q1 earnings report on Friday the 14th.
- Despite fears of a banking crisis, Citibank's held-for-sale and trading securities are likely to be marked higher amid a favorable 3-month liquid bond and equity market environment.
- Citi's ex-market debt portfolio is at risk of lower recoveries and heightened cyclical exposure. However, we expect the segment to have delivered robust results in Q1.
- The bank's CET 1 ratio is set to improve if its EPS target is realized. Additionally, the firm's growing tangible book value and its trailing P/B of 0.49 supports a deep value argument.
- C stock is technically undervalued as it is trading below its 50-, 100-, and 200-day moving averages. Moreover, Citi's broad-based Q1 earnings outlook is bright.
Citigroup Inc. ( C ) is due to release its first-quarter earnings report before the market opens on Friday, April 14th. Citi's stock has shed more than 10% of its market value during the past month amid talks of a potential banking crisis, which raises the possibility that Citi stock might be oversold. Therefore, a positive earnings report may send Citi stock into stardom. However, trivially speaking, the opposite is likely to occur if Citi misses its earnings estimate, especially considering the level of systemic risk currently attached to global financial markets.
It is estimated that Citi will deliver stronger earnings than in its previous quarter, with analysts setting a normalized earnings-per-share target of $1.71 and a revenue estimate of $20.108 billion.
Considering the aforementioned, the question now becomes: Will Citi's Q1 earnings report live up to expectations? Let us delve into a deeper discussion to find out.
Is Citigroup Expected To Beat Earnings?
Without any concrete guidance, the best way to forecast Citi's earnings is to use its previous earnings report and interpolate it with the use of market-based factors. Although this approach is simplified, it provides valuable insight into what Citi's Q1 earnings report will contain.
Loans
Citi's loan portfolio has illustrated robust growth during the rising interest rate environment, eclipsing the cost of its deposits to achieve a year-over-year increase of 2.39% in NII in Q4. The bank's ex-market debt portfolio has surged in the past year, and we anticipate much of the same as interest rates remain elevated. Although Citi's financing costs have also risen, its ability to generate arbitrage profits from its loan portfolio is second to none as it has a robust market position.
Furthermore, there is little price risk involved with non-market loans, which isolates them from the market-based impact that talks of a banking crisis might have had on corporate balance sheets.
Due to the uncertain economy, a critical component of Citi's debt portfolio is the ratio between its allowances for bad debt and charge-offs. Establishing a trendline paints a clearer picture of Citi's prospective loan performance.
Based on Citigroup's financial statements, the bank reduced its allowances for credit losses account by 8% in the past quarter, which is likely due to its 36% jolt in recoveries. In our view, this is a highly positive sign. Still, we fail to see how the scenario could reoccur in Q1, as it was reported in March that U.S.-based credit card delinquencies rose by an additional 0.16%, U.S. mortgage delinquency rates are trending upward , and U.S. auto loan defaults are also trending upward with a current 0.43% year-over-year increase.
Citi's U.S.-based data shows signs of pressure on consumer balance sheets. The data could soon spill over into Citi's other trading regions and wreak havoc, considering that the global economy is on a cyclical downtrend.
Although Citi's debt portfolio is primarily exposed to developed markets and high-quality credit, the bank does business in cyclical industries such as mortgages, small business loans, and personal balance sheets. Moreover, Citigroup's emerging market exposure has increased in recent years. Collectively, we think the bank's debt portfolio is overly exposed to rising credit spreads , an inverted yield curve , and other cyclical features. Thus, its credit activities will likely hit an unfavorable inflection point if the economy resumes its worrisome trajectory.
Securities
As of December 2022, Citi's held-for-trading debt securities spanned approximately 47% of its total market-based investments. Despite a shock from systemic risk arising from a 'banking crisis', global bond indices still gained value in the past quarter/ and month. Therefore, Citi will likely have higher values assigned to its AFS debt in its Q1 earnings report.
Furthermore, Citi's held-for-trading equity securities are also likely to be marked up in Citi's Q1 report. Based on retrospective data, global equity markets have attained significant value since the turn of the year, allowing for a potential increase in Citi's asset base.
On the other side of the spectrum, we are slightly concerned about Citi's deposits. The bank experienced a 9% draw on deposits during its previous quarter, and the SVB Financial Group's (SIVBQ) collapse might have spooked a few of Citi's depositors in Q1, resulting in a drag on the bank's primary funding source. Nevertheless, we believe there will be a net gain in the firm's securities-based income and value.
Citigroup's Capital Adequacy, Valuation, and Dividends
For those unaware, the tier 1 common equity capital ratio measures a bank's financial strength relative to its current risks related to the market, interest rates, and its operational infrastructure. Based on the bank's metrics, Citigroup has gradually increased its CET1 in recent quarters, which is impressive considering the unstable interest rate environment and 2022's bear market.
Theoretically, a bank's CET 1 ratio can be improved by lower risk or by a firm adding to its equity value via increased retained earnings, an asset-to-liabilities surplus, higher common stock value, additional paid-in capital, tax assets, and related items.
In our view, interest rate and market risk both remain elevated. Thus, we see little change in Citi's CET 1's risk basis for Q1. However, with all else constant, if Citi delivers analysts' forecasted $1.71 in earnings-per-share, it will increase its CET 1, leading to an improved risk outlook. Additionally, at a dividend payout ratio (cash and stock) below 30% , Citi's EPS contribution will likely have a net positive effect on retained earnings.
The bank's recent build-up in tangible book value somewhat backs up the aforementioned argument regarding a better CET 1. Moreover, it supports a higher implied valuation for the stock as banking stocks typically oscillate around their price-to-book values.
Although Citi's dividend payout needs to be factored into play, its price-to-book ratio of 0.49x conveys that its stock is undervalued. Even if a worst-case scenario of a weaker-than-anticipated Q1 had to occur, the odds are that the bank's P/B will remain at a discount, lending investors a deep value opportunity.
Lastly, Citigroup pays a stellar dividend yielding 4.45%. More importantly, Citigroup's 5-year dividend CAGR of 12.74% and dividend coverage ratio of 2.84x indicates that the company's dividends are sustainable. Therefore, Citi stock falls into the "bird-in-hand" category, meaning investors will likely assign a lower risk premium to the stock as a significant portion of its returns accrues from safe dividends.
Final Word: How Could Citi's Q1 Earnings Impact Its Outlook?
Based on our analysis, Citigroup is set to deliver a strong Q1 report. Although fears of a banking crisis influenced the firm's stock, its balance sheet likely proliferated in Q1 as the market environment for held-for-sale debt was supportive in the past three months. Furthermore, a heightened net income per share estimate raises the possibility of a higher tangible book value and an improved CET 1 ratio.
Even though risks such as lower quarterly debt recoveries and cyclical asset exposure cannot be neglected, Citigroup's broad-based prospects seem bright, and we anticipate its Q1 earnings report to meet expectations.
Citigroup stock is trading below its 50-, 100-, and 200-day moving averages and presents a lucrative dividend. Therefore we think the stock lends investors a lucrative entry point ahead of the bank's Q1 earnings report.
For further details see:
Citigroup Stock Q1 Earnings Preview: What To Watch For