"You can look at the earnings estimates on Citi, and we think it potentially has 50% upside from here...get Jamie Dimon on the phone, ask him if there's one franchise he'd like to buy in the world...he'll say Citi's foreign business." - David Tepper in his January 22 Bloomberg Interview
Four years into this bull cycle, it's become relatively difficult to find investment opportunities that offer 50% returns, so when a big name like Tepper comes out and pounds the table for a highly-publicized stock that's already run quite a bit, it definitely piques my interest.
I'm definitely bullish on the financial sector, particularly the major money center banks. Starting with the bigger, industry-wide picture, the fundamental thesis is strong and continuously improving. My recent article explains my industry thesis, which can be summarized as follows:
- A steadily improving housing market
- Improved consumer credit trends
- Net interest margins that are nearing the bottom
- Organic revenue growth will pick up from "traditional" banking products like mortgage origination, business lending, and credit cards given a modestly improving global economy, hindered only by a massive deleveraging that is nearing its end
From an investment standpoint, I believe financials remain one of the most undervalued major sectors. The combination of public distrust, concerns regarding "credit risk," and the incredibly widespread belief that these banks are "black boxes" has ensured that the sector is underweighted in the majority of portfolios.
Given these factors, Citigroup (C) appears to have plenty of macro tailwinds behind it. On to the company-specific story.
Tepper's bold remarks in regard to Citi's foreign business is what caught my attention, as it sounded like an interesting catalyst that I haven't heard much about.
In Citi's 2012 annual report, operating results were broken into North America, EMEA, Latin America, and Asia.
Latin America & Asia
In a year in which overall revenues stalled, Latin America was a bright spot for Citi. This segment was responsible for 21% of Citigroup's revenues; Latin American securities and banking operations revenues were up 27% yoy, while the global consumer banking and transactions segments grew 2% and 5%, respectively.
Latin American consumer banking revenues rose 9% in fiscal 2012, largely due to Citi's rapidly growing Mexican operations. Citigroup believes that due to exceptional growth in the working-age Mexican population, "credit [will expand] three or four times faster than the rate of economic growth." Citi was early to Mexico, and is now positioned to reap the benefits, even as former rapid growers like Brazil cool off.
Total Latin American revenues were $14.5 billion in 2012. By comparison, JPMorgan (JPM) typically generates only $1 billion in annual Latin American revenues. Citigroup's massive relative scale in Latin America reduces its exposure to ultra low interest rates and squeezed net interest margins.
Citi has also been the front runner in Asia. Citigroup became the first American bank to issue its very own credit cards in China, where higher-end customers will be targeted.
For all the talk of a Chinese property bubble and slowing growth, lending is still extremely profitable in the communist nation. Nominal GDP growth in China is around 15%; borrowing at 4-6% and lending at something like 10% is very lucrative. China will continue to grow at a superior pace relative to developed economies and banks like Citi will generate huge fees fueling it.
In addition to one-time charges, losses derived from Citi Holdings - Citi's so-called bad bank - once again distorted Citi's annual bottom line.
2012 brought the sale of Citi's 49% stake in Smith Barney, resulting in a $2.9 billion after-tax loss. Citi Holdings' assets declined 31% to $156 billion, which still consumes 15% Citi's overall risk-weighted assets.
Citi has $8.4 billion in mortgage loan loss reserves, and it may begin to release these as the most toxic loans have been unloaded off the books. While Citi Holdings is unlikely to break even in 2013, it should by the beginning of 2015. If we ignore the near $6.6 billion loss in 2012 ($2.9 billion of which was a result of the aforementioned Smith Barney sale), Citigroup's net income was actually $14.1 billion, or $4.70 per share, in comparison to the stated $2.44.
Citi took a $1 billion charge on restructuring in Q4, as it announced the cutting of 11,000 jobs. Add in another $1 billion ($.33 in EPS), and Citi's adjusted EPS becomes about $5.
Assuming that by FYE14 Citi Holdings is breakeven, I think it's quite plausible that Citi will meet consensus FY14 EPS of $5.23, given cost cutting (over $1 billion in annual savings from layoffs), extremely modest developed world revenue growth, and the continuation of growth in key markets like Latin America.
At market close on April 2nd, shares of Citi traded at $44.11. To reach Tepper's call for 50% upside, C needs to trade at about $66 a share.
If Citi does indeed earn $5.23 in FY14, a goal that appears very realistic, Citi would need to trade at 12.5 times earnings. Is that doable? Once again, I believe it is. We all know US banking won't be quite as profitable as it once was thanks to extensive additional regulations. However, the banking industry is more consolidated than ever, emerging market growth remains strong, developed world deleveraging is in its later stages, and net interest margins are likely two-three years out from bottoming. A 17% discount to the historical market multiple would be a fair price to pay for Citi.
Additional disclosure: Long Citigroup LEAPS