- Shares are trading at a significant discount to its book value unlike its peers in the industry.
- Return on Assets while not best in class are certainly respectable, yet the shares trade lower than similar competitors.
- Bad assets held in Citi Holdings continue to be worked down which will lead to a much higher return on asset figure.
The financial crisis that began in 2007 managed to devastate the economy with banks being particularly hard hit. The banking industry required a federal bailout which subjected the industry to a much higher level of oversight. Some of the banks have managed to emerge from the crisis in better shape than ever as evidenced by their respective share price trading at a level above the highs seen in 2007. In my estimation the bulk of the gains in these shares have already been attained, thus the search leads to those who have yet to fully participate in a banking sector recovery. The article below will detail the opportunity that Citigroup (NYSE:C) currently offers the patient long-term investor.
I would like to begin the analysis of C with an examination of in my view the two most important figures that pertain to banks. The first metric revolves around the book value of the company, which has particular value for a bank. Book value is a simple number derived from the company's total assets minus its liabilities. As we can see from the chart below, C is trading at a level that is far lower than their respective book value indicating that investors are valuing the entire operation for less than the assets it holds. This type of discount is usually assigned to companies that are significantly out of favor such as C.
Recent Share Price
Return on Assets
Bank of America (NYSE:BAC)
JPMorgan Chase (NYSE:JPM)
Wells Fargo (NYSE:WFC)
The second metric revolves around return of total assets. This figure is used to indicate how much the company earns on all of its outstanding assets. A number above one indicates the bank is well run and earned a very acceptable return. As we can see form the chart above, C lags behind some of its rivals as the bad debt taken on in the years prior to 2007 continue to haunt the bank. Interestingly, the ROA for C is very similar to those posted by JPM and TD which are trading at above book value, in TD's case far above book.
To deal with the bad debt on the books and to shield the better-performing assets, C has created a "bad bank" and has placed all of its non-performing debt into this entity dubbed Citi Holdings. Non-performing debt drags down a bank's ROA figure, ergo depressing profitability. It is critically important for C and its shareholders that the assets in Citi holdings continue to shrink and at bare minimum operate at a break even rate. The following excerpt is attributed to John Gerspach CFO of Citigroup and was presented at the Raymond James Financial Institutional Investors Conference.
To begin, let me take a moment to show the progress we have made in Citigroup since 2011. Our return on assets has improved steadily from 52 basis points in 2011 to 72 basis points in 2013, driven by earnings growth in our core Citicorp franchise and a significantly reduced drag from our wind down portfolio in Citi Holdings .
At the same time, we have actively reduced our balance sheet to just under $1.9 trillion and shifted the mix of assets to Citicorp from Citi Holdings, which today represents just 6% of our balance sheet.
Citicorp earned $15.4 billion in 2013 as we grew loans to offset the impact of spread compression globally while reducing our expense base.
In Citi Holdings we cut the net loss in half to under $2 billion in 2013, driven principally by declining credit costs at our legacy mortgage portfolio.
These results reflect Citi's ongoing transformation over the past six years, as we have reduced our size and complexity while investing in Citicorp. While we have made a lot of progress, we still see significant opportunities to improve our performance and returns going forward.
First is continuing to improve the efficiency of Citicorp by allocating our resources to the most productive markets, products and client segments, as well as leveraging our global scale.
Second is driving Citi Holdings closer to breakeven as we continue to wind down the assets in an economically rational manner and move past our legacy legal issues.
And finally, our goal is to increase the amount of capital that we return to shareholders over time. We ended last year with capital levels above both our targets and our expected regulatory requirements. Going forward we believe we can generate significant additional capital driven by retained earnings, as well as the wind down of Holdings and the utilization of our deferred tax assets, or DTA, which I'll discuss more in a moment.
Our goal is to return a growing portion of the capital we generate back to shareholders over time, thereby maintaining a compact balance sheet and driving improved returns on tangible common equity.
As we can see from the CFO's comments, assets held in Citi Holdings continue to shrink along with losses from this division. It is not unrealistic to expect over the course of the next few years that Citi holdings will at bare minimum be operating at a break even status with an even smaller revenue base. I have no doubt that if this does indeed come to pass that C's ROA will be much higher.
I would now like to focus on the last part of the CFO's statement pertaining to return of capital to shareholders. Realistically speaking, any sort of capital return to the beleaguered shareholders of C has been absent since 2008. Yes, I realize that C has been paying out a dividend of one penny per quarter however I consider it miniscule at best. An investor may not have to wait much longer for a meaningful dividend hike as the Fed is expected to release the results of their stress test at the end of the month. Once the results are revealed it is widely anticipated that banks will announce their new dividend rate for the year. I doubt C will be allowed to begin paying a 2% dividend, even though earnings could easily support a roughly 94 cent per share annual payout. Most pundits are expecting a lower number ranging from twenty to forty cents per year which would still work out to a dividend rate of less than 1%. In my opinion it will take 2-3 years of continued strong performance before C will be allowed to pay a dividend rate of at least 2% of its share price.
In conclusion I would like to summarize my thoughts on how this trade may play out. I anticipate over the course of the next 2-3 years that C will trade up to roughly $65 its book value. A return to book value from the $47 level would translate into a gain of roughly 38% which would be very acceptable. Dividends received haven't been factored in as I expect them to increase as the years go by and bad debt is worked off. My numbers are a bit conservative, yet I prefer it that way as you stand a better chance of having an "upside "surprise. Thank you for reading and I look forward to your comments.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.