Citigroup Inc. (C) was embarrassed during the 2008 Great Recession, nearly ending its reign as one of the largest banks in the world by assets. Its stock lost over 99% in value, reaching a high of over $500 and a low of just under $1. This sharp decline in market capitalization represented the second-worst percentage loss during that time of all 500 companies in the S&P 500. American International Group (AIG) suffered the worst loss.
Those days are far behind Citigroup. The firm has settled on its current Chairman and CEO Michael Corbat, who has worked for Citi most of his life. He recently led Citi's Europe, Middle East, and Africa operations, so he understands the value of a successful global business. Corbat has focused on rigid cost cutting and better risk management since he became CEO in April 2012. As a result, the megabank bank has appreciated 45% in value since then to over $52 per share. However, the firm still has room for growth. Of all the large cap banks in the United States, Citi generates the most revenue from outside North America. In the first half of 2013, Citi's non-North American revenue stood at 56%. Emerging market revenue in this same period was 43% of total revenue, and emerging market pre-tax earnings were 49% of total revenue. Citi truly takes a global approach to its consumer and investment banking businesses unlike any other bank.
|Non-North American Revenue as % of Total||(%)|
|Goldman Sachs (GS)||41|
|Morgan Stanley (MS)||23|
|J.P Morgan Chase (JPM)||19|
|Bank of America Merrill Lynch (BAC)||13|
As you can see, Citi's global business model allows it to sustain a competitive advantage over its rivals. The potential for emerging and developed market economic and credit growth outside the U.S will best serve Citi on a relative basis. Loan losses have remained very stable over the past few quarters in these markets.
2Q 2013 Takeaways
1. Citigroup reported 2013 second quarter earnings last week and posted a positive surprise. The company earned $4.2 billion, or $1.25 per share, compared to the consensus analyst estimate of $1.18. This represents a 25% increase from the second quarter in 2012 and 6.3% positive surprise. Revenue came in at $20 billion, representing an 8% increase from the second quarter of 2012 and a 1.2% positive surprise. Citi also improved its financial health, as the Tier 1 common ratio increased to 10% on a Basel III basis. The firm leveraged slightly under 13 times on a tangible book basis, relative to pre-recession levels of nearly 79x! This has yet to be finalized according to Corbat, but the firm is in a great position to meet its capital requirements.
2. Citi's securities and investment banking businesses saw better-than-expected growth. Investment banking revenue increased to $1 billion, a 21% improvement. While the fixed income segment increased by 18% to $3.4 billion, the equity segment saw dramatic growth of 68% to $942 million. This was a result of more frequent equity underwriting deals and stronger derivative performance.
3. Corbat has set financial goals for Citi. He hopes to increase return-on-assets to at least 90 basis points and return-on-equity to 10% by 2015. Shareholders can therefore check his performance over time. Citi has yet to reach the double-digit return-on-equity numbers it saw before the recession, but the numbers have greatly improved since then.
Another important takeaway from the second quarter earnings report is Citi Holdings. Citi's toxic assets are contained within the Citi Holdings unit. They consist mostly of mortgage-backed securities, and they have decreased steadily since 2008. The number of toxic assets totaled about $800 billion in 2008, and that number has been reduced to $131 billion, or just 7% of total assets. Corbat notes that this quarter was the largest decrease in Citi Holdings assets since 2010, partly due to selling the remaining 35% stake in the Morgan Stanley Smith Barney brokerage business but also due to improved revenue in the U.S mortgage market. In addition, Citi has nearly $55 billion in deferred tax assets. This future tax write-off will be used to further improve the company's capital position.
The combination of the improvements with Citi Holdings and a future $55 billion asset have caused investors to wonder whether Citi will increase the amount of capital returned to shareholders. Citi's current dividend yield is a weak 0.08% compared to the industry average of 1.44%. Last year, Citi failed the now required "stress test." This meant that the federal government prohibited the company returning capital to shareholders in the form of either dividends or buybacks.
This year, however, Citi passed the test and has therefore boosted the confidence of investors and federal government officials in the firm's ability to build an adequate amount of capital. More importantly, this year's test has been a confidence-booster and a major victory for the management team. Federal regulators approved a $1.2 billion buyback program starting in 2014. This very well may signal the beginning of a different policy on returning capital to shareholders. Citi is expected to increase its quarterly dividend payout to 15 cents per share in 2014 and 40 cents per share in 2015, according to Macquarie Capital analyst David Konrad.
4. One of the most important performance measures for bank stocks is net interest income and net interest margin. This measure tells investors how much a company is earnings on its assets and how much it is paying on its liabilities. Likewise, the net interest margin is an easy way to gauge the performance of a company's investments. For Citigroup, net interest income grew 3% from last year's quarter to $11.7 billion. The firm's net interest margin decreased by 3 basis points, due to slightly lower loan yields. However, the company is on track to improve on its 2.82% net interest margin for 2012. This performance metric should improve over time as Citi makes better use of its investment decisions.
In sum, Citi and its investors are optimistic about the company's outlook, but it will take a long time for the company to reach pre-crisis levels:
Our results for the second quarter reflected a continued challenging operating environment, with spread compression, slowing global growth, and elevated legal and related costs remaining as headwinds. However, even with these challenges, we continued to grow our core businesses while significantly reducing the earnings drag from Citi Holdings.
Citigroup looks like an attractive investment on a valuation basis. The stock is currently trading at discount to its $62 book value per share. Analysts cite that 10-20% premiums to book value are most common for bank stocks. Given Citi's growth potential in emerging markets relative to other banks, this is certainly not an unreasonable reality.
Better yet, the company's stock is trading at a sharp discount on a price-to-earnings basis. The current forward P/E ratio of Citi is 12.05, relative to its industry average of 23.99. If we assume that this will not change, then we arrive at a price by the end of 2014 of $65.50 using the analyst EPS consensus estimate of $5.44. This represents an upside of 26%. Also, keep in mind that Citigroup may start to increase buybacks and dividends in the near future. This should boost investors' returns.
The combination of Citigroup's improved balance sheet, attractive valuation metrics, and a new CEO with a unique global focus should benefit those who invest in the stock. The company's global business model is its largest asset, as it presents many opportunities in credit growth outside the regulated U.S financial industry, but it also represents the company's biggest risk. Credit growth is one way for a bank to become very profitable, but as we saw in 2008, it can have devastating consequences. Emerging markets have historically been extremely volatile relative to developed markets, and therefore investors must take this risk into their investment consideration.
Even though this risk should not be ignored, Citigroup has a major advantage over its competitors through its global focus. While the company becomes more leveraged in emerging markets, like China and Latin American countries, other domestic-focused banks will struggle in the current weak environment for loan demand, especially in the U.S and Western Europe. This global approach shows that Corbat is focused on creating value for its shareholders and developing its own unique value proposition. Combine this with future earnings from improvements in Citi Holdings, a future $55 billion tax write-off, and more cash returned to shareholders, Citigroup is a very attractive investment right now.