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Introduction

Despite the recent miss in earnings I remain optimistic on Citigroup because of growth in its consumer banking services, improving economic conditions, along with declining loan loss allowances.

Qualitative Analysis

Source: Information pertaining to Citigroup came from the shareholder annual report, with additional information from the Citigroup quarterly report, investor presentation and the Wells Fargo & Company/JP Morgan Chase annual report.

Citigroup (NYSE:C) is a diversified bank financial services holding company that provides a host of financial products and services for consumers, governments, and corporations. The broad range of businesses includes lending, asset management, and advisory. Citigroup is globally diversified.

Citigroup has been experiencing growth in overseas markets, with Latin America being its fastest growth market for consumer banking.

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The Latin America division grew its revenues by 9% annually in 2012. Growth in international markets such as Latin America will continue to further support Citigroup's long-term growth.

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Citigroup's fastest growing divisions are the global consumer banking (7% growth in net income) and the Securities and Banking division (27% growth in net income). Growth in these two divisions will further support Citigroup's long-term growth.

The Basel Committee on Banking Supervision has finalized the Basel III regulation for determining regulatory capital, and when fully phased in by 2019, will require a tier 1 common equity to risk-weighted assets of at least 7.0% for small banks. For bigger banks the equity to risk-weighted assets will be 8-10.5%.

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Citigroup currently meets the capital requirements imposed for globally systematically important banks (G-SIBs). The Basel III requires 7% plus an additional 3-3.5% in Tier 1 common equity capital totaling 10-10.5% for common equity by 2019 for systematically important banks like Citigroup. Citigroup meets Basel III requirements by a safe margin.

Many in the financial media have cited that the shadow inventory of houses would collapse any hopes of a long-term housing recovery. This has been proven to be incorrect as the American population has continued to grow by 3 million people a year. Population growth implies a demographic need for housing. Economists estimated that there is pent-up demand and that household formation will return to 1.2 million a year as job conditions continue to improve (unemployment rate is currently 7.9%). During 2011 only 845,000 housing units were built annually over the last four years, with demolition and destruction of homes from demolition, and natural disaster (Katrina, Sandy, etc.) resulted in a 250,000 decrease in the number of homes on average (4-year average). The growth of households is likely to absorb pre-existing housing supply, this implies growth in Citigroup's lending, and that new loans may be able to off-set losses from its pre-existing lending portfolio.

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Mortgage delinquencies have continued to decline throughout Q4 2010 to Q4 2012. Implying that the amount of anticipated loss reserves set aside for loans that go into default will continue to decline going forward. We can further establish this by looking at the chart below.

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Because of declining loan delinquencies, Citigroup has been able to estimate lower allowances for loan losses. This reduction in loan loss allowances will result in higher profit margins, and earnings growth. This is the primary reason for high earnings expectations from the banking sector.

The wall-street reform act (Dodd Frank) will result in higher deposits held by banks, and banks not being allowed to speculate using bank-money. Fee income generated by merchant card activities (Banks issuing Visa & MasterCard's) will also decline due to the Durbin Amendment. This may have an adverse effect on earnings going forward. On the positive, Citigroup has many upside catalysts going for it: declining loan loss allowances, improving economic conditions, rising demand for mortgages, along with double digit growth from its securities & banking division.

Citigroup competes with Bank of America (NYSE:BAC), Wells Fargo & Company (NYSE:WFC), JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Lloyds Banking (NYSE:LYG), HSBC Holdings (HBC), Black Rock (NYSE:BLK), Charles Schwab (NYSE:SCHW), UBS (NYSE:AG), among many others.

Technical Analysis

Citigroup has been on a continuous up-trend since the beginning of 2012. I anticipate the company stock to trend higher after its recent break above the symmetrical triangle formation.

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Source: Chart from freestockcharts.com

The stock is trading above the 20-, 50-, and 200- Day Moving Average. The stock is in a confirmed up-trend (higher highs and higher lows), the up-trend further supports my buy-thesis, and the confirmed break above the symmetrical triangle formation will further support the positive momentum behind the stock.

Notable support is $33.00, $36.80, and $40.00 per share. Notable resistance is $45.00, $51.17, and $54.30 per share.

Street Assessment

Analysts on a consensus basis have reasonable expectations for the company going forward.

Growth Est

C

Industry

Sector

S&P 500

Current Qtr.

8.10%

53.00%

-94.00%

6.90%

Next Qtr.

11.00%

75.40%

-92.80%

16.50%

This Year

19.70%

35.00%

22.50%

6.20%

Next Year

12.60%

12.20%

6.50%

12.90%

Past 5 Years (per annum)

-30.01%

N/A

N/A

N/A

Next 5 Years (per annum)

10.44%

2.15%

10.67%

9.02%

Price/Earnings (avg. for comparison categories)

9.02

11.93

16.23

12.55

PEG Ratio (avg. for comparison categories)

0.86

2.24

0.72

3.91

Source: Table and data from Yahoo Finance

Analysts on a consensus basis have a 5-year average growth rate forecast of 10.44% (based on the above table).

Earnings History

12-Mar

12-Jun

12-Sep

12-Dec

EPS Est

1

0.89

0.96

0.96

EPS Actual

1.11

1

1.06

0.69

Difference

0.11

0.11

0.1

-0.27

Surprise %

11.00%

12.40%

10.40%

-28.10%

Source: Table and data from Yahoo Finance

The average surprise percentage is 1.4% above analyst forecasted earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

P/E Multiple

2003

$ 3.63

13.37

2004

$ 3.76

12.81

2005

$ 3.90

12.44

2006

$ 4.17

13.36

2007

$ 0.60

49.07

2008

$ (6.42)

-

2009

$ (7.99)

-

2010

$ 3.65

12.93

2011

$ 3.73

7.05

2012

$ 2.44

16.21

Source: Table created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.

The EPS figure shows that throughout the 2003- 2006 period, the company was able to grow earnings. Throughout 2007-2009 earnings contracted. The contraction in earnings was due to the great recession. Following the recession the company was able to grow earnings.

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Source: Table created by Alex Cho, data from shareholder annual report

(Note: The EPS figures presented were the original EPS figures for the period represented and were not adjusted for dilution or splits.)

By observing the chart we can conclude that the business is cyclical and is affected by macroeconomics. Therefore the largest risk factor to Citigroup is the slowing of international gross domestic product growth. So as long as the United States economy continues to grow, the company will generate reasonable returns over a 5-year time span based on the forecast below.

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Source: Forecast and table by Alex Cho

By 2018 I anticipate the company to generate $7.76 in earnings per share. This is because of cost management, growth in core businesses, and improving economic outlook.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.

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Source: Forecast and chart by Alex Cho

Below is a price chart incorporating the past 10 years and the next 6 years. Detailing 16 years in pricing based on my forecast and price history on December 31st of each year.

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Source: Forecast and chart created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.

(Note: From 2003 to 2010 there were ten times the number of shares; adjusting for the price of the stock would involve multiplying by 10 in order to arrive at a fair valuation.)

Investment Strategy

C currently trades at $42.02. I have a price forecast of $63.11 for December 31st 2013. Generally undervalued stock will experience sudden rallies in order to fetch a reasonable premium relative to historic valuation, or book value. I factored that into my price forecast, making it an important component behind the forecasted stock valuation.

Short Term

Over the next twenty-four months, the stock is likely to appreciate from $42.02 to $63.11 per share. This implies 50.1% upside from current levels. The stock is in an up-trend, which further supports my investment thesis.

Investors should buy Citigroup at $42.02 and sell at $63.11 in order to pocket short-term gains of 50.1% during 2013 to 2014.

Long Term

The company is a decent investment for the long-term. I anticipate C to deliver upon the price and earnings forecast despite the risk factors (competition, regulation, economic environment). C's primary upside catalyst is improving economics, international growth, growth in financial products, and managing costs. I anticipate the company to deliver upon my forecasted price target of $105.58 by 2018. This implies a return of 151.2% by 2018. This is an excellent return for a financial company.

A higher yielding investment opportunity albeit having higher risk is to buy the Jan 17, 2015 calls at the $45.00 strike. The call premiums trade at $6.15. The price forecast for the end of 2014 is $70.58. The rate of return if the calls expire at $70.58 is 315.9%, the option will break-even when the stock trades at $51.15.

The risk to reward ratio on the option strategy remains high. The high-returns comes with high risk (5-year beta of 2.5)

Citigroup has a market capitalization of $127.3 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity.

Conclusion

Investors should remain optimistic on Citigroup because of growth, and cost-cutting. I am strongly convinced that the stock will out-perform the Standard and Poor 500 going into 2013, making it an appealing investment opportunity for those who are willing to take on the higher risk.

The conclusion remains simple: buy Citigroup.

Source: Citigroup Has Potential Despite Its Earnings Miss