US banking stocks are indicating an upward surge as earnings reports for the industry showed impressive performance over the last quarter. The industry as a whole has been subject to increasing regulatory pressures in the post crisis scenario. Also, the top line growth for banks in the US has shown signs of stagnation. The economy as a whole is facing a low interest rate environment which has been adversely affecting the margins for banks. In the face of such circumstances, banks have done a decent job in recent quarters to project earnings growth through focused cost cutting on various fronts of the business. Through this analysis, I'm to evaluate Citigroup (NYSE:C) against its peers as a prospective investment opportunity.
Industry Performance and Positioning
Banking stocks have been recovering in recent periods due to improvement in some key sectors of the economy. Specifically in terms of consumer confidence, housing prices and the overall economic activity in US, the recovery appears to be in sight.
The above chart shows the stock performance of Citigroup, Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC), the four large players in the financial services industry, over a period of one year. The chart shows that in this reference period, the stock prices for all these banks have shown a substantial appreciation. The chart also shows that Citigroup has outperformed its peers over this period by projecting an increase of 88%. I expect this upward movement of bank stocks to continue over the next few years as the economic recovery reaches a stage of maturity and the Federal Reserve begins to consider the tapering process.
Interest Margins and Regional Exposure
Low interest rates have been a source of continuous threat to the banking industry. The depressed net margins have been compensated by Citigroup's improved performance in capital markets. At the same time, in recent quarters, the company has indicated an improvement in the interest margins situation.
Source: FY13Q1 Earnings Presentation
The above chart shows Citigroup's net interest revenue and net interest margins over the last nine quarters. The chart shows that the revenues have declined in the first quarter of FY13 as compared to the previous quarters but simultaneously, the net interest margins have improved in the last four quarters. The margins experienced in the first quarter are substantially above the average for FY11 and FY12.
The company has also demonstrated a decent performance by managing its exposure to different economies. Approximately half of the company's global consumer banking revenues come from North America which is why the overall mix of global exposure is vital to the company's overall performance.
Source: FY13Q1 Earnings Presentation
The above table represents the credit exposure of the company to the global economy. The table shows that Citigroup has less than 3% exposure to the EMEA region. This is a good sign as conditions in Europe have shown substantial deterioration over recent years. At the same time, the 30.6% exposure to Asia is expected to serve as the key growth driver as the Asian region continues to grow strong. The same can be inferred regarding Latin America. Most importantly, the credit risk of the company has been globally diversified. This approach protects the company from region specific risks.
Update on Cost Management
Citigroup has settled its dispute with a federal agency which made an accusation that the bank had mislead Fannia Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) into a $3.5 billion of MBS involvement. The details of the settlement, specifically the settling amount, have not been disclosed by both parties. Some analysts have also speculated that the bank did not pay a high amount for this settlement. Despite the fact that many related disputes with US banks are still unsettled, such reductions in litigation costs show a positive indication as the banks can continue to focus on their core operations.
Citigroup maintains its strong position in the banking industry despite the high degree of competition. The standing of the company is also supported by improved results declared in the first quarter as these results beat analyst estimates on revenues and earnings.
Data Source: Morningstar
The above table shows the key valuation metrics of Citigroup as compared to the major players in the industry and the overall industry average. The table shows that the company is undervalued across three of the four valuation metrics against the average of major players and the industry. The undervaluation provides a sizable upside potential for investors.
The prices of banking stocks have started to show a strong upward surge which is supported by the recovery in the economy. At the same time, the company's management of global exposure and settlement of litigation costs has reduced potential risks for the future. Also, the net interest margins have improved despite the low interest rate environment of the overall economy. These major upside factors, coupled with the undervaluation of the bank as compared to its peers and industry, show a strong upside potential. Based on these factors, I propose a buy recommendation for Citigroup.