Citigroup Looks Overpriced

As a heads up, this is a relatively short article. This is not an in-depth look into the future earnings of the major banks, but rather a simple observation from an exercise I happened to be doing and thought I would share.

I was looking at different financial stocks after the close yesterday to see how various banks have fared over the past couple days. Market leaders like Goldman Sachs (GS) and JP Morgan (JPM) have had tremendous rallies off the March lows, helped in part by an excellent quarter for trading revenues.

However, lately the real price action has been in the bank stocks that were seen as too risky early on in the recent rally. Traders were bidding Bank of America (BAC) up like crazy on the news that hedge funds were taking large positions in the company.

Now it seems like some of that price action has moved over to Citigroup (C). Jim Cramer has been on several rants lately about what a great deal Citigroup is at this level, even going so far as to suggest a Sovereign Wealth Fund should buy a 10% stake from the US government.

My question is simple: given the massive rally we’ve had over the past six months, which banks are now becoming overpriced? Six months ago, anyone would have told you that the business models were broken and it was almost impossible to fairly value the bank stocks.

Well now that we have a return of stability and normalcy to the markets, I think it’s worth comparing these banks' future earnings. I’ve put together a table below with the six major banks ranked by how secure I feel they are perceived in the public eye. It will give you a quick look at the premium people are willing to pay right now, compared to average earnings estimates for this year and next.

I realize this is not perfect because predicting these future earnings will have a large margin of error, however it is still a good comparative basis. (As a disclosure, all average earnings estimates were pulled from Yahoo Finance)

I’ve bolded what I find most surprising about this little exercise. Despite the move into Citigroup lately and Jim Cramer’s repeat endorsements, the company is still only expected to earn $0.09 in 2010.

The only other major bank still expected to post a loss in 2009, Morgan Stanley (MS), is expected to earn $3.14 in 2010. Not only are analysts predicting an anemic profit for Citigroup in 2010, but also the expected revenue growth really doesn’t seem to justify its current stock price. I think because of its comparatively low stock price, Citigroup looks to some like the bank stock that’s lagging the recent rally.

However, with a forward P/E ratio of 46 and a rally of better than 300% off its March low, I think Citigroup is beginning to look very overpriced.

There are clearly many factors in play that are not represented in the above numbers. This was merely an exercise that happened to show something interesting. I don’t think we will see Citigroup go bankrupt anytime soon, however, it was probably the most badly damaged of the still surviving banks.

This stock has been swept upwards with all the other survivors, but I think the profit forecasts look considerably bleaker than its peers.

Disclosure: Short C

Comments

[noendinsight:]

The authors reasoning is weak and he is short and has been for a while. Enough said.

Aug 19 08:34 AM

[thevoice@vo...:]

Huge reduction in operating expenses: Pandit iterated that they have reduced expenses by 25%. In the past several months Citi has cut its expenses by almost $4 billion per quarter. If Citi can keep or reduce the last quarter number of $12 bill. expenses, this will further increase bottom line numbers.

Credit card losses seem to have stabilized. Citi was the only big bank that had the same default rate on credit cards as April ( as opposed to BAC for example), delinquencies rates fell for the second month in a row (remember that delinquencies are directly correlated with the real credit losses, not the default rates). In addition, Citi has limited exposure to commercial real estate (only 2.5% out of the estimated stress test losses).

Citi has greatly reduced their risk exposure, this is evident in the 1Q data.

Aug 19 09:28 AM

[perremon:]

Think. What is their business advantage? Operating in over 100 countries, Citigroup represents the world's most global financial services company. International B2B transactions are it's great and unmatched strength. That infrastructure is difficult to replicate. When World trade begins to heat up then todays price on Citi will look mighty good in retrospect. Being long on Citi shouldn't mean being concerned about it's price next week in my view.

Aug 19 10:57 AM

[Emerald:]

Citi, although a risky investment, is a great bet on the future in five years. I anticipate I will make at least a 25% annual return by 2014 as their poor investment portfolio stabilizes. My return will be higher if they get a new CEO. It's not a $50 stock, but it sure will be a $20 stock before splits. I am long "C" and feel very comfortable taking this bet.

Aug 19 11:43 AM

[Bill L.:]

My concern isn't on the top or bottom line, but the government will force a break up of Citi once the economy has stabilized, in some effort to reduce systematic risk. If their forced to split, any earnings forecast will be unreliable. I'm not a bull or bear on the stock, but what sums up my feeling on the stock is this; if you're a buyer, you are braver than I.

Aug 19 02:46 PM

[Ryan Pollack:]

I would just stay away from Citi. Some comments concerning the breaking up of the company and they have sold off prime assets already are warranted. Future earnings power is going to be muted. But they won't go out of business either because the gov't is backing them so shorting at these levels is not a great idea either.

Aug 19 03:44 PM

[Kansas City...:]

As far as contrarian indicators go, Jim Cramer has been fantastic for me. I respect the guy for putting his money where his mouth is, but every stock of mine hes recommended has been after an amazin streak and the stock has plummeted since (I think because I may not be the only guy using this indicator). For example, I owned ATI at 20, so it go to around 40 and then since Cramer recommended it at its peak it is back to 26-27. There are other factors, but its fishy. And don't stand behind, "in the long run" its a good stock crap. That's the same reason not bankrupt lenny dykstra never had a loser, because he never sold them.

Aug 19 05:01 PM

[sofla100:]

C has had some heavy insider buying. Including a Board Member recently purchasing 100,000 shares at $4 a share. Unless the company is going bankrupt, and the government won't let that happen, downside risk is minimized. Plus, I think they likely have rigged earning forecasts to the downside. As for shorting it, your going to short bank stocks now? Go ahead, make our Board Member even happier, that is when you get squeezed!

Aug 19 05:31 PM

[E.D. Hart:]

AIG was a global franchise too, but they crashed and burned on bad bets in the derivatives markets. Arguably, AIG will never return to its former glory.

The same can be said of Citigroup. There is no precedent for the current environment--its global deleveraging that will take a decade or more to work through.

There is no reason that they must return to their former glory--they may just be broken up and sold off in pieces to make up for bogus book value.


The closet analogy may be Japan and their deleveraging of their real estate and financial sectors. In 1989 3 of the words largest banks were Japanese. In 1999 none of them were. They are still recovering.

Citi may not be much different than the walking wounded Japanese banks--still recovering after 20 years. How can you value a company if the experts say you cant accurately determine the book value?

Aug 19 05:35 PM

[aarc:]

As far as technical analysis is concerned; citi is still bullish and can run up to 4.61 to 5.92 short-term before requiring several weeks of correction that can last 4 to 6 months.

On the bigger picture; citi can make a total run toward 10.21 before it will require a major correction that will span several months and can last a year to a year and a half.

For me, I am long citi. My conservative target is 8.40 once citi breaks above the last high of 4.48.

Overall, I intend to sell portions of my holdings at targets and buy them back after the necessary corrections.

Citi is much maligned in the US among common folks. Look elsewhere outside the US and most of their affluent citizens respect citibank. Follow the money, 20% of populations controls 80% of global wealth. Citi need only to cater for that 20% of population and they can control a significant portion of the wealth on earth.

Aug 19 06:28 PM

[The_Cisco_Kid:]

Seriously I am not even a professional investor but let me point out the obvious.

This guy chose to quote the absolute lowest of 17 analysts EPS estimates for next year, the actual estimates were .09-.40. Also Analysts dont include 1 time profits, C is selling 26 business units that have causing them losses, that's 26 more 1 time profits!

finapps.forbes.com/fin...

The very same estimates this analyst quotes also puts the book value of the stock at $6 per share, which means its currently undervalued based on book value much less a multiple of the book value based on its earnings potential.

Also Analysts put Citi expected earnings for 2011 through the roof, this is a great buy/price for long term investment 3-5 years.

Last but not least this "analysts" disclosure is to short C. With such completely bias analysis with nothing but the lowest EPS estimate for next year as his entire gauge, my analysis is that this analyst is a shorter who wrote this to further his own agenda, probably shorted it around 3.85 and is worried about how he is going to pay his bills.

-Shawn

Aug 19 07:31 PM

[cstauffer:]

C is a purely a speculative investment in my book. As a professional investor, meaning that I am trusted and use my discretion to invest other people's money, no one can truely say that they understand Citi's businesses and therefore the various risks inherent in this company. For those who point to insider buying, technical analysis or simply blind faith, you are not acting as investors, you are speculating or betting that because insiders are buying or certain technical patterns have developed that the stock will continue to rise. These reasons are void of any "homework" as Cramer says needs to be done before buying a stock. If the "homework" was done, most everyone would come to the conclusion that their risks are still too opaq and that the visibility into their future business model is non-existent. What this means is that they cannot be adaquately valued and therefore any purchase of C can only be defined as speculative.

Aug 19 09:43 PM

[jayminho:]

2 to 3 ytears from now, citigroup will probably emerge as a huge street bank, filling the gaps of washing mutual and many others.

Aug 19 10:21 PM

[DonFurio:]

Just because you say you are using a simplistic approach, doesn't mean you are correct. The reality is that C will start to trade on 2011 expected earnings in the early parts of 2010. C is still roughly 90-95% down from the level it was for most of the 2000's and even with the massive dilution, new share issuances and the fact the C has sold off some profitable assets, if you believe C will survive into 2011, then there is still tremendous upside potential, much more potential than holding spiders.

So many people love to talk about movement from the bottem, but guess what, C was trading for a buck because many idiots including many SA posters and authors thought it was going to be a grea idea to nationalize C and B of A. When will you idiots admit you were wrong?


On Aug 19 08:21 AM Logan Smyth wrote:

> I tried to make it abundantly clear that this is a very simplistic
> approach, but not one that is still somewhat worthwhile. Clearly
> I don't think that Citigroup will earn $0.09 EACH year, but that
> is still the average estimate for 2010. Even if you use the most
> bullish analyst estimate of $0.40 for 2010, you are already trading
> at essentially 10x 2010 earnings. You should also consider the fact
> that a large government ownership stake will likely limit how much
> risk they can take, which is exactly what helped Goldman and JP Morgan
> benefit from the recent rally. I'm sure they will earn more than
> $0.09 a year at some point, but their profit growth is still the
> lowest of the bank stocks mentioned and it's trading at the highest
> premium.

Aug 20 09:38 AM

[Shabba:]

I actually think it is underpriced. I understand the approach, but the stock price you're projecting here is completely a function of what earnings you ASSUME the bank will have. Is it reasonable to assume that Citi will earn that much less than it's peers given that it is doing substantially the same things as the other banks? I don't think so, but it is debatable.

I think the stock drew more fire during the crisis because of all the ridiculous media coverage. People were afraid to go near it. It is still priced like it is completely bankrupt (liquidation value) eventhough the federal gov. has said that will never happen. This stock has nowhere to go but up, even in a horrible economy which I think we'll see over the next couple of years.

Aug 20 11:42 AM

[Ricard:]

Interesting article. As the author admitted, it is rather simplistic, and to assume Citi Holdings will be a permanent part of the picture is IMHO also not realistic.

I've been looking for articles that can convincingly portray a short argument for C, and do not think this is up to that standard. For me, that's great news - I have a leveraged long position in C that I've held since $2.50.

Using similarly simplistic analysis, if one were to look at just Citicorp (not Citigroup) and annualize its Q2 earnings over 1 year, you'd get a market cap of $120 billion. It assumes that the government will take responsibility for Citi Holdings with their 34% stake and cash out. If that were to happen, C's outstanding shares would be reduced to around 15 billion, putting a per share price of around $8.

That's the case I argued a couple of weeks ago:
seekingalpha.com/artic...

Aug 20 01:17 PM

[ebworthen:]

You may as well say that our government appears overpriced.

They won't let Citi fail, but come this Fall, we might see sub 1$ shares all over again before the FED halts trading of thier stock.

Aug 20 11:13 PM

[SonOFSpam:]

How's that short position working out? Losing money on your C short, and losing money on your Shipping and Nat Gas longs. Do you ever make money with this pump & dump scheme?

Aug 21 08:19 AM

[jayminho:]

hahaha i was wondering the same.
he is shorting a stock that is 95% down.
you just cant be any dumbier, can you ?
by the time of the post the stock was at 3.90s
now topping 5

anyway, he is 23..
lets give him a break


On Aug 21 08:19 AM SonOFSpam wrote:

> How's that short position working out? Losing money on your C short,
> and losing money on your Shipping and Nat Gas longs. Do you ever
> make money with this pump & dump scheme?

Aug 24 12:28 PM

[Madacasto:]

Yahoo???? Ya-what you talkin' bout Willace?

Aug 24 02:39 PM