Investors in Citigroup (C) should take some money off the table according to analysts at Goldman Sachs. Analysts note that after significant momentum this year investors should be cautious especially as capital return plans become more uncertain in the near term.
I can only agree with analysts and would advise investors to take profits as well. After closing the gap to tangible book value, I see few drivers for further excess returns.
Goldman Takes Profits
Analysts at Goldman Sachs (GS) lowered their rating on Citigroup from "Conviction Buy" to "Neutral". The two notch downgrades is accompanied by a $60 price target, suggesting some 15% upside from current levels.
Analyst Richard Ramsden notes that the stock has outperformed the wider market significantly after being added on the bank's "Buy" and "Conviction Buy" list. All of the drivers which could result in strong capital results have occurred in the meantime and the current valuation is a better reflection of Citi's core franchise.
Despite the downgrade, Ramsden notes that the bank is best positioned to return capital with the introduction of much more onerous capital rules for large-cap banks. Yet Citi's capital return story is more muted in the near term than expected, further limiting the return on equity improvements.
These latest comments come as a big surprise to me, especially the good position of the bank to return capital. The stock still has to recover from the crisis as capital returns are still negligible at a penny a quarter.
Back in October Citigroup released its third quarter results. The bank ended the quarter with $121.7 billion in total Basel Tier 1 Common Capital, up 9.4% on the year before. Basel-III risk-weighted assets fell by 2.3% to $1.16 trillion. As a result, the Tier 1 Common Capital Ratio improved by 110 basis points to 10.4%.
Revenues for the first nine months of the year came in at $58.6 billion, up 14% on the year. Net earnings rose by 77% to $11.2 billion. At this pace annual revenues are seen around $79 billion as earnings could come in around $15 billion.
Trading around $52 per share, the market values Citigroup at $158 billion. This values the bank at 2.0 times annual revenues and 10-11 times annual earnings.
The quarterly dividend of a penny results in a dividend yield of less than 0.1% per annum.
Some Historical Perspective
For long-term investors, all the latest price moves are almost irrelevant. After witnessing significant dilution during the crisis, shares are still trading with losses of around 90% compared to ten years ago.
Back in 2007, shares traded at prices of around $550 per share, after being adjusted for a reverse 1-for-10 stock split. Shares fell to lows around $10 in 2009 to steadily recover to current levels around $50 per share.
In the aftermath of the financial crisis, Citigroup has been cutting costs and dealing with past issues to become a healthy bank again. Profits have been restored, and the balance sheet has been repaired at the moment.
Recent good news came from the Federal Stability Board saying that Citigroup will only have to add 2 percent point of its risk weighted assets on top of the minimum requirements of 7% of risk-weighted assets. Previously Citigroup had to add 2.5 percent point of risk-weighted assets on top of this minimum.
The 0.5% reduction in the requirements nearly frees up $6 billion in capital given the current balance sheet of nearly $1.2 trillion in risk-weighted assets. Investors are pleased with this news, as is it allows the firm to pay out an amount of $2 per share to investors, if approved by regulators.
Back in December of last year, I last took a look at Citigroup's prospects. I concluded that investors applaud the restructuring efforts of incoming CEO Corbat which announced 11,000 job cuts. The cuts were deeper and more aggressive than those made by former CEO Vikram Pandit which has been ousted, failing to grow the business and shareholder returns in the aftermath of the crisis.
Shares traded in their mid-thirties at the moment, and have risen by nearly 50% ever since. The strong returns result in shares trading near their tangible book value at the moment. Clearly the market is still seeing Citigroup as an underperformer in the industry, as it trades at a very small discount to the tangible book value. This compares to premium valuations for other banks.
While previously Citigroup was my least preferred financial on the back of its history, lack of dividends and poor earnings, I applauded Corbat's job cuts announced last year. I furthermore noted that the easy part of restructuring has been done, while it became time to formulate a credible growth strategy for the future. Well, Corbat has delivered on meaningful and profitable revenue growth this year, and the market has applauded this, sending shares little over 30% higher so far in 2013.
Therefore I can largely agree with Goldman. After such a big run-up and closing the gap to its tangible book value, it might be time to be more cautious. The bank is trading at fair value. While further earnings growth and a serious dividend hike could unleash further upside potential, I would advise investors to be cautious.