Citigroup Perennial too-big-too-fail battleground stock Citigroup (NYSE:C) has been a source of much debate since Citigroup nearly went out of trade during the financial crisis and shares traded for $1. The company has put that sordid past well behind Citigroup and is back to making lots of money, but for some reason, Citi still doesn't command the respect that other banks do. The company's earnings multiple is consistently below that of its peers and other financials despite what I consider to be obvious evidence that such a discount is no longer warranted. Citi recently reported earnings, and investors reacted favorably to the news, so in this article, I'll take a fresh look at Citi in rally mode to see whether Citigroup is still as cheap as I think Citigroup is.
To do this I'll utilize a DCF-type model you can read more about here. The model uses several inputs including earnings estimates, which I've borrowed from Yahoo!, dividends, which I've estimated to grow at 20 cents annually, and a discount rate, which I've set at the 10-year Treasury rate plus a risk premium of 6.5%.
The model produced a fair value of about $66, roughly $12 higher than where the stock trades today. That would imply significant upside, but that is a story I - and others - have told for a while at this point. Let's take a look and see if this time could be different.
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As I mentioned in the introduction, Citi continues to be saddled with a subpar valuation in comparison to its peers when I see no reason for this to be the case. Citi trades at only 9.1 times forward earnings, the multiple that most companies receive when they are on their way to their respective death beds. Citi is fairly the opposite; Citi was very shut death and was saved only through the swift action of regulators, but that Citi is long gone and the one that exists today is nothing like the one that nearly went out of trade several years ago. Citi's TBTF competitor set all trades at 9.8 times forward earnings or greater, so Citi really is being given quite the disadvantage among direct competitors.
But why is Citi shown such displeasure from investors? For the life of me, I don't get it. Let's examine some data points from the most recent quarter in order to get a sample of what I mean. Citi made almost $5 billion final quarter, hardly the hallmark of a company that is in some benevolent of perilous situation.
Citi is a very well run company at this point, and I have a lot of faith in CEO Corbat and what Citigroup and his team have been able to accomplish since taking over. Citicorp's efficiency ratio is down at 54%, a very strong number that bests many banks across the size spectrum. Citi wouldn't be able to achieve the profitability it has with destitute expense control and in a low interest rate environment, it is all about expense controls. Citi gets it and that's why I think it deserves more credit.
Speaking of terrible interest rates, Citi's net interest margin is about average among large banks at just below 3%. This has been a problem for a long time for Citi and others and it will continue to be until rates rise. When that will be is anyone's guess, but Citi is primed for outsized EPS when rates do rise. Citi's current profit rate on interest income is pretty low but it is still able to produce more than 100 bps in return on assets. Imagine rates 100 or 200 bps higher as funding costs remain low; Citi would be a genuine powerhouse in terms of growing earnings and that's what I'm counting on.
This and other information build the fact that Citi is trading below tangible book value even more incredible. No other large bank is really even that shut to its tangible book value at this point as holdout Bank of America (NYSE:BAC) crossed that threshold some time ago. Again, banks that consistently trade below tangible book value are generally the ones that are losing money or have some other skeletons in the closet; you don't see successful turnaround stories trading under that threshold.
Apart from all of this, Citi's strong fundamentals led the Fed to approve its robust capital return plan following this year's edition of the CCAR. Citi managed to actually raise its dividend and while the payout itself is still basically meaningless, it signaled the end of the era where Citi was constantly in the Fed's penalty box at CCAR time. The fact that Citi raised its dividend is great news and it means that the bank is in much better shape than it was. The company also received permission to buy back almost 5% of the float after the CCAR, a huge tailwind for earnings in the future.
I think Citi is doing all the right things right now. Citi Holdings continues to wind down and as losses dwindle there, overall profits will continue to move up. The Fed gave permission for a huge capital return boost and although rates are still taking their toll on Citi's ability to build money, I believe that makes the higher rate catalyst that much more exciting. Citi is also using its strength to retire tall cost sources of capital in order to build the balance sheet for the future. In other words, Citi is in better shape than it has been in perhaps the final decade, so I see zero reasons why it should stay in the valuation penalty box and trade for only 9 times forward earnings. I think we'll see Citi continue to blow it out of the water and investors will finally commence to respect it with a peer multiple. See you at $65.
Disclosure: The author is long C. (More...)The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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