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Citigroup (NYSE:C) shares have bounced strongly from their year lows of $24 to trade at $47 recently. Since hitting their 52-week high of $47.92, shares are only off slightly to $47 as of this writing. With the company's new CEO, Michael Corbat, firmly in charge of the bank and legacy toxic asset issues being wound down slowly, are the shares fairly valued? This article will take a look Citi's estimated fair value based upon its future earnings and dividends.

To do this, we'll use a DCF-type approach that requires some assumptions: 1) discount rate of 10% 2) dividend estimates based on my assumptions 3) perpetual growth rate of 3% 4) earnings estimates from Yahoo! Finance. I have used what I consider to be reasonable estimates; you may disagree with some or all of my numbers but keep in mind all forecasting is subject to conjecture and risk.

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$4.70

$5.32

$6.04

$6.85

$7.78

x(1+Forecasted earnings growth)

13.20%

13.50%

13.50%

13.50%

13.50%

Forecasted earnings per share

$4.70

$5.32

$6.04

$6.85

$7.78

$8.83

Equity Book Value Forecasts

Equity book value at beginning of year

$52.90

$57.56

$62.63

$67.92

$73.77

$80.05

Earnings per share

$4.70

$5.32

$6.04

$6.85

$7.78

$8.83

-Dividends per share

$0.04

$0.04

$0.25

$0.75

$1.00

$1.50

$2.00

Equity book value at end of year

$52.90

$57.56

$62.63

$67.92

$73.77

$80.05

$86.88

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Normal earnings

$5.76

$6.26

$6.79

$7.38

$8.01

$8.69

Forecasted EPS

$4.70

$5.32

$6.04

$6.85

$7.78

$8.83

-Normal earnings

$5.76

$6.26

$6.79

$7.38

$8.01

$8.69

Abnormal earnings

-$1.06

-$0.94

-$0.75

-$0.52

-$0.23

$0.14

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

Abnormal earnings disc to present

-$0.96

-$0.78

-$0.57

-$0.36

-$0.14

$0.08

Abnormal earnings in year +6

$0.08

Assumed long-term growth rate

3.00%

Value of terminal year

$2.73

Estimated share price

Sum of discounted AE over horizon

($2.72)

+PV of terminal year AE

$1.54

PV of all AE

-$1.18

+Current equity book value

$52.90

Estimated Current share price

$51.72

Given my assumptions, C has an approximate fair value of $51.72 per share right now. Knowing that shares are trading about 10 percent lower than that amount at the time of this writing, shares look like a cautious buy. Before you hit the "buy" button though, we need to understand what this number means.

First, it's important to understand what this fair value calculation really means. It implies that discounting Citi's earnings at 10% to compensate for the time value of money and the risk that the company will not achieve those targets still nets a fair value in excess the current trading price. This means that even with a relatively high bar to clear with a 10% discount rate, shares are reasonably valued. In essence, the fair value price is the price at which the company is still a good buy given your discount rate. As C is trading below that amount, it passes that very important test with a small margin of safety.

Second, the $51.72 is not the forecasted nominal price six years from now. Rather, it is the net present value of the company's forecasted earnings at a 10% discount rate. Given the company's current forward PE of 9, shares would be trading at roughly $79 in 2018 if the forward PE remains the same and Citi achieves earnings of $8.83 per share.

Lastly, if you look at the "Dividends per share" line in my model, you'll see that I'm forecasting C will only pay about $5.44 per share in cash dividends from 2013 to 2018. That implies you've got roughly 11% of the current share price headed your way in cash distributions over the next few years given my assumptions about cash dividends. Of course, nobody can forecast what C's dividends will look like for the next 6 years, but I have provided what I believe to be reasonable assumptions about C's ability to generate cash and distribute it to shareholders. Citi's dividend, more so than its too-big-too-fail brethren, is a huge wildcard. The company famously went with a laughable share repurchase program for 2013 instead of paying an increased dividend. I don't believe this will persist but it has caused me to ratchet down my expectations of huge dividend increases from Citi in subsequent years.

There are risks to my upside forecasts, however, as there are with most of the big banks. First, Citi still has billions upon billions of dollars of toxic assets it acquired during the run up to the financial crisis. These assets are largely quarantined into Citi Holdings but shareholders are still responsible for the losses that may be incurred. Corbat is doing a great job of continuing the work of ousted CEO Vikram Pandit in disposing of these toxic assets in the most profitable manner possible. However, any lack of execution could lead to larger-than-expected losses. Second, the mortgage/refinance boom that occurred through about the end of last year appears to be losing steam and that is cause for concern industry wide. Citi is less concentrated in mortgages than Wells Fargo (NYSE:WFC), for example, but a significant slowdown in mortgage origination activity could be an impediment to earnings growth. Finally, net interest margins have been under pressure for the banking sector since quantitative easing began and so far, they have not begun to significantly rebound. Given the uncertain outlook of interest rates due to the never ending zero interest rate policy environment in which we live, NIM may not rebound for a few years and in fact, may get worse before they get better.

However, none of these are new risks and I have to think management is planning for these. While the lack of a dividend is disappointing with Citi, the execution and foresight management has shown in dealing with Citi's legacy issues and forming a new, leaner Citigroup gives me confidence the stock will be moving higher in the coming years. However, the lack of yield and the fact that the company is only 10% below my fair value estimate means I think the shares need to pullback before you should buy. At current prices, a lot of Citi's earnings growth is already priced in and as such, the margin of safety is lower than I would like. However, Citi is a great franchise that is under terrific management and should provide shareholders with respectable capital appreciation in the coming years, even if the dividend is still a ways off.

Source: Citigroup Turnaround In Full Effect