Citigroup (NYSE:C) is one of the large banks that I never spent much time studying. Charlie Munger, Walter Schloss, Warren Buffett, and Seth Klarman never expressed much interest in it, opting instead to establish stakes in Citigroup's better capitalized peers. The company needed some well-documented cash infusions (read: bailouts) from the US government during the worst of the crisis, and I never could quite get my head around the company's share dilution over the course of this past business cycle.
In 2007, Citigroup had 499 million shares outstanding. Now, the company has over 3 billion shares outstanding. When the common shares outstanding sextuple over a short period of time due to capital raising (as opposed to acquisitions), it is hard to take an investment seriously knowing that you only have a claim on 17% of each profitable dollar today in comparison to where you would have been before the financial crisis hit.
But still, as the facts change, so must my analysis and opinion as well. At the time when Citigroup had to raise $14.5 billion in 2008 and execute the first set of dividend cuts, the company's Tier 1 Capital Ratio was only 7%. Those days are gone. As of the most recent quarter, Citigroup's Tier 1 Capital ratio is now 12.60%.
The company isn't going anywhere-despite the admonitions that the "too-big-to-fail" banks needed to be reduced in size, Citigroup currently has $1.86 trillion in total assets (and growing). That compares to a high of $2.10 trillion in assets on the precipice of the financial storm in 2007. The difference between 2007 and 2013 is that, although Citigroup is nearly as big now as it was then, the 2013 version of the bank is almost twice as capitalized as the 2007 version.
Since 2010, the profits have steadied. The company earned $3.60 in profits in 2010, $3.69 in 2011, $3.86 in 2012, and normalized profits of $4.70 by the end of 2013 once you manually remove the one-time earnings impairments. The dividend has been stuck at a penny per share because the company could not afford to let any of these profits enter the pockets of shareholders because the banking giant needed to shore up its balance sheet and continue cleaning up its excesses from the financial crisis.
Although Citigroup's reputation is still maligned, its balance sheet is now telling a different story as the company has become well capitalized and will no longer have to devote the entirety of its earnings to satisfying balance sheet requirements. In other words, we should be looking at a dividend increase within the next year or two.
For a good chunk of Citigroup's pre-crisis history, the company was able to devote 25-50% of its profits to go out to its owners in the form of a cash dividend. The payout ratio above 40% occurred in the three years leading up to the financial crisis, so those days are likely too optimistic to include in our projections. And plus, when a company resumes a dividend payment, they rarely "bite off more than they can chew" and jump right into it, but rather they start at a low payout ratio so that they can have a five to seven year run of rapid dividend increases so that they can generate goodwill and satisfaction among the shareholder base (for analogous examples, look to how General Electric, Pfizer, and Wells Fargo have played their dividend increases after the cut).
That means, in the interest of conservatism, we should be looking for a dividend that constitutes 20% or so of profits to be announced sometime within the next twenty-four months or so. At $4.70 per share in total profits, that would mean a dividend somewhere around $0.94 per share annually, or about $0.23-$0.24 per quarter.
Thereafter, I would expect Citigroup to rapidly raise its dividend by 10% annually for a few years, as shareholders benefit from the simultaneous forces of increasing earnings accompanied by an increasing payout ratio to the 30% or so mark. Considering that the optimistic analysts are predicting profits of $7-$8 per share within the next five years, the company could be paying out $2 per share in dividends for shareholders with long-term orientations and a willingness to "skate to where the puck will be" (in Wayne Gretzky terms) by recognizing that Citigroup's earnings are rapidly advancing, the balance sheet is cleared up, and the penny per share that has been a source of ridicule for three years now is finally in a position to rise.
Part of being a contrarian investor entails buying an asset when it is unloved. It is hard to be more disliked than Citigroup these last few years. But when you look at the balance sheet, many of the problems that existed in 2008 have been improved or fixed entirely. The company's book value now stands at $63.15 per share, well above the current $50 per share price. Unless a company has a liquidity crisis (see Wachovia), it is hard to go wrong with bank investing when you initiate your purchase at a price less than book value. Considering that the company is trading below book value, and considering that the Tier 1 Capital Ratio is now well above 12%, it seems that Citigroup's balance sheet is finally reaching the position where the company will be able to return 20% or so of the $4.70 in profits to shareholders within the next twelve to twenty-four months.