The catalysts for this decline, he stated, are the relentless strengthening of the dollar relative to foreign currencies with particular regard to the yen and euro, and a looming recession.
With the shares down $1.98 on Tuesday and 3.04 billion shares outstanding (shares have since dropped modestly further), Citigroup is apparently worth about $6 billion less as a result of this "new" information.
Citi does about half of its business in foreign countries, so with the dollar making unusually big moves against the yen and emerging market currencies like the Turkish lira, Indian rupee, and Mexican peso, the worry is of course that when the revenues are translated back into dollars, they'll come in weak. Fair enough, but more than a $6 billion drop in the market capitalization as a result of currency fluctuations -- which we know are highly dynamic -- is difficult to justify.
The resulting fluctuations likely won't effect net income, but could result in a decline of the bank's book value and tier 1 capital. However, Citi ended Q1 with a Basel I tier 1 capital ratio of 11.8%, well above the required 6%. Citi reiterated this morning that it expects to end this year with at least 10% in tier capital.
Peabody seemed to suggest that the currency fluctuations could effect net income if the bank has to devalue a foreign asset or business; this is a stretch, and a one-time writedown wouldn't be reflective of the long-term earnings power of Citi. Of course, Citi also hedges its foreign currency risk, so it's not like its facing the full brunt of the dollar's strength.
Citigroup Remains Substantially Undervalued
I recently argued that David Tepper's thesis for 50% upside in the shares is rather plausible, and I expect Citi will be trading ~$65 a share by the end of 2014. This implies roughly a 12.5x multiple on FY14 estimates.
Excluding the $2.9 billion sale of Smith Barney to Morgan Stanley, Citi Holdings lost about $3.7 billion in 2012, or $1.21 per share. Adjusting 2012 EPS of $3.86 for a breakeven Citi Holdings, C made $5.08 per share.
Citi Holdings has continued to shed assets; they made up only 8% of Citi's consolidated assets as of Q1, down from 8.6% in Q4 2012. I expect the holdings corp. to be breakeven by YE14.
Citi also took a $.33 restructuring charge in Q4 2012. If you want to get aggressive and assume Citi Holdings will be breakeven shortly while also adjusting for temporary restructuring charges, you're looking at a C EPS of $5.40, implying a 9.25x multiple on current earnings.
With regard to dividends (something C investors haven't really enjoyed in quite some time), a normalized payout ratio around 20-25% would payout 2-2.5% annually -- all we need is clearance from the Fed.
Citigroup's gem is probably its Latin American business. Citi generated $14.7 billion in revenues there for 2012, compared to JPM's $1 billion. With 21% of consolidated revenues derived from Latin America, Citigroup has avoided the compressed net interest margins that have plagued competitors like Wells Fargo (WFC).
With business growing in Latin America and global securities and banking activity continuing to be strong, Citi has meaningful top-line drivers. In the context of $5.40 adjusted EPS, even modest organic income growth over the next few years makes Citi a particularly attractive investment. Last week's sell-off offers a nice opportunity to obtain a clean entry point around $50 a share.