- Citigroup remains a bargain as the shares trade below its tangible book value of 56.89 per share.
- The norm for the company before the financial crisis was 1.5-2.2 times book value which would value the shares at a minimum of $85 per share.
- Citi Holdings which comprises all of the bad loans actually posted a profit this quarter.
I originally wrote my bullish thesis on Citigroup (C) in March with the expectation that the bank would pass the Fed stress test and would be allowed to return excess capital to shareholders via dividends and share repurchases. The shares were trading at roughly 80% of tangible book value which I viewed as an absolute steal. In light of Citigroup's recent stellar earnings report, I have decided to re-examine my bullish stance towards Citigroup.
Warren Buffett, the legendary investor has mentioned that book value is the best indicator of value for financial companies. He has used the growth in book value as the primary measurement of his success at Berkshire Hathaway (NYSE:BRK.B, BRK.A), so I will begin my examination of Citigroup with a discussion of the company's book value. Citigroup has managed to grow its tangible book value from $53.10 in the second quarter of 2013 to its current level of $56.89. The growth in book value equates to a 7% gain, which I view as quite satisfactory. If we examine the chart below, we will notice the shares of Citigroup have gone basically nowhere yet the underlying business is sound and growing at a nice clip. In my view, the shares are a true bargain awaiting a catalyst that will lead the shares much higher. I believe there are two catalysts that will lead the shares higher over the next 18 months. I will detail them below.
+C Book Value (Per Share) data by YCharts
C data by YCharts
The first catalyst is the continued wind down of Citi Holdings, the repository of the parent companies non-performing loans. I was particularly heartened to see Citi holdings post an actual profit this quarter as the holdings group balance sheet continues to shrink. Citi holdings currently hold $111 billion in assets worth roughly 6% of the parent companies' total assets. Three billion is assets were sold in the second quarter with $3.8 billion pending and expected to close in the third quarter. 2.7 billion of that figure are the consumer assets held in Greece and Spain, two EU members that have suffered considerable economic contraction over the past few years. The outright sale of these assets will greatly aid in my view the parent company's ability to pass the next stress test scheduled for early next year.
C Price to Book Value data by YCharts
The second catalyst for the shares is Citigroup's ability to pass a stress test conducted by the Fed next year. I highly suspect they will pass next year and were held back for political reasons this year. I suspect the government dangled the ability to pass the test as a carrot, inducing Citigroup to settle the mortgage probe for roughly $7 billion dollars. The settlement along with Citigroup's divestiture of some of what may be deemed riskier assets (Citi Holdings as detailed above) such as the recently disposed of consumer units should pave the way for an approval.
What type of share appreciation can one reasonably expect with the above backdrop in mind? I believe the company will easily trade above tangible book value with a target of its actual book value of $66.76 as a realistic scenario for the first half of next year. My target would imply a 30% plus upside from here which may actually prove a bit conservative.
I would like to examine what would happen if Citigroup were to actually fail the next stress test. The Fed has decided to conduct annual stress tests to determine the ability of the major banks to withstand different economic shocks. The test are hypothetical, yet the idea behind them is to attempt to ensure we won't suffer another 2008 type financial meltdown. If a bank is able to pass the test, the regulators will allow them to return excess capital to shareholders in the form of dividends and share repurchases. If Citigroup is unable to pass in 2015, the bank dividend will remain stagnant. I believe the downside here is rather minimal as the shares are trading at discount to the assets it actually holds on its books.
In summary, I view Citigroup as significantly undervalued and will be adding to my shares on any sort of pullback. I believe the financial companies will revert back to their pre crisis multiple over book value in the next couple of years. I am positioning myself to capitalize on this trend with Citigroup and Allstate (NYSE:ALL) whom I recently wrote about. I would like to thank you for reading and look forward to your comments.