2023-10-16 13:00:00 ET
Summary
- Citigroup's earnings suggest that banks don't expect macroeconomic conditions to worsen. However, lower-income consumers could face more pressure.
- Compared to JPMorgan, despite its strong valuation grade, C's underperformance highlights the importance of relative efficiency metrics in assessing investments.
- Citigroup is undergoing a significant transformation to improve its management and reporting structure and meet its medium-term RoTCE target.
- I discuss why the market is right to reflect a steep valuation discount on C. However, I'm confident that much pessimism has been priced in, but patience is necessary.
- C could continue underperforming in the near term. However, the current levels seem highly attractive if you have confidence in its transformation journey.
Citigroup, or Citi ( C ), released its third-quarter or FQ3 earnings release last week. Its earnings suggest that banks aren't expecting macroeconomic conditions to worsen, even as they expect lower-income consumers to face more pressure. As such, management's commentary aligns with its large bank peers, anticipating a resilient US consumer to underpin the strength of the US economy moving ahead.
C Vs. Peers (1Y total return %) (Seeking Alpha)
Despite that, C has significantly underperformed JPMorgan ( JPM ) stock over the past year on a total return basis despite boasting a best-in-class "A" valuation grade. Accordingly, C posted a 1Y total return of 0.78% compared to JPM's nearly 40% total return.
As such, I believe JPMorgan's market leadership and strong RoTCE ( 22% for FQ3 ) performance have outweighed concerns over its premium valuation ("D" valuation grade). Therefore, JPM's relative outperformance over its peers has been astounding, suggesting investors should focus on relative efficiency metrics to assess their investment thesis.
Citi posted a RoTCE of 7.7% for FQ3, well below its medium-term target of between 11% and 12%. As such, I'm not surprised that CEO Jane Fraser has pledged to undertake a significant transformation of the company's management and reporting structure. Citigroup's undertaking to slash costs and lift its efficiencies is critical to improving analysts' and investors' confidence in its ability to meet its medium-term RoTCE target.
Accordingly, management articulated that "transformation remains Citigroup's top priority." As such, the "substantial changes" made to the bank's organizational structure aim to "eliminate layers, duplication, and complexity," improving accountability and execution. Management stressed that the move is expected to "eliminate over 15% of regional and functional roles at the top two layers."
However, the bank wasn't ready to update on the progress of its transformation. As such, management assessed that an update in FQ4 would be more appropriate, allowing the bank time to make the necessary changes. While I applaud Citigroup's ambitious move to continue its restructuring, bank investors would likely remain cautious. They need assurance from management that Citigroup remains on track to meet its medium-term RoTCE outlook. However, its execution still has much room for improvement before investors would appreciate the undervaluation of its stock.
Notably, Citigroup delivered a solid FQ3 earnings release, outperforming analysts' estimates. Accordingly, Citi posted an adjusted EPS of $1.52, well above Wall Street estimates of $1.22.
Accordingly, Citi's critical Institutional Clients Group, or ICG, performed well, posting a 12% increase in revenue. The bank experienced solid gains driven by "double-digit growth in services, markets, and banking." In addition, Citi's Treasury and Trade Solutions, or TTS, also performed remarkably, posting a 12% growth in revenue, driven by a 17% increase in net interest income. Management stressed it was the segment's "highest revenue quarter in the last decade," underscoring Citi's solid recovery.
Despite that, I believe investors aren't focused so much on near-term growth metrics, but on how Citi's ongoing transformation roadmap could help it bridge its RoTCE outlook. Therefore, until management can provide more confidence that its structural changes are working, investors are justified to remain cautious.
C price chart (monthly) (TradingView)
As seen above, C has dropped back into its October 2022 lows, underpinned by the $40 support level. While I have confidence that the zone is expected to hold robustly, C investors must remain patient about expecting a sharp upward reversal.
As explained previously, management's progress on its recent changes needs to be assessed as it looks to bridge the gap in its medium-term RoTCE outlook. My bullish thesis on C is based on a mean-reversion setup supported by its cheap valuations.
However, if the $40 zone were to be breached, I urge investors to consider appropriate risk management measures to protect against unanticipated downside risks.
Rating: Maintain Strong Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Citigroup: The Market Isn't Foolish - It's Cheap For A Reason