Too many traders, and even investors, view the market tick by tick, with no credence given to the notion that stocks are pieces of actual companies. Too many traders worry about what will happen tomorrow, this week, this month, or even this year. Some stocks, however, only pay off years down the line.
We feel that Citigroup (C) is one such stock. Nearly 3 years after coming to the brink of the abyss, Citi is a changed company, with consistent profits and a Tier 1 Capital ratio of 11.6%, and will end 2012 with a Basel III ratio of 8-9%. But this will occur not because of massive losses, but, as John Gerspach, Citi's Chief Financial Officer, said in their second quarter earnings release:
We expect to begin returning capital to shareholders next year and end that year with an 8%-9% Tier 1 Common Capital Ratio under Basel III.
A bank that is not confident in its prospects would not begin returning capital to shareholders. There was a time when Citi was the ugly duckling of the banking world. Now, B of A (BAC) is that ugly duckling. But Citi is still trading like one, at a discount of 44% to its tangible book value per share of $48.75 as of the end of the 2nd quarter. Citi is being thrown in with B of A and European banks, even though it is neither.
Unlike B of A, which has become a bloated tangle of assets and operations, seemingly cursed for being the largest bank in America, Citi has made great efforts to streamline operations and dispose of non-core assets and businesses, via Citi Holdings. And Citi has been doing a good job of this, with a 34% reduction in assets as of the end of the second quarter, as well as an incredible 82% reduction in losses. Soon, Citi will be only Citicorp, a global bank poised for long-term success thanks to its strength both here at home, and in the developing world.
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Citi has far less mortgage exposure than B of A and little direct exposure to European sovereign debt. Certainly, it is possible that these will be issues, but we do not see these issues as warranting a 44% drop in Citi's book value. Investors in B of A are right to question the bank's stated book value, since it is riddled with toxic Countrywide mortgages, mortgages that Citi is less exposed.
Citigroup does have exposure to this segment, but strong refinancing activity should be able to help shield the bank from possible subprime issues. But, are we blind to reality? No, we recognize that while Citi is no B of A, it is certainly no JPMorgan (JPM) which trades at a 22.3% discount to book value. While we do see that as a "ceiling" to Citi's stock, as well as the stocks of all major US banks, we still see Citi as an attractive long-term holding, given its strong position in emerging markets, which while possibly a short term liability, will be a long-term advantage, and something that no major US bank has.
There will be a day in the future where Citi trades at a premium to book value. And we are perfectly willing to wait for that day.
Can Citi decline further from where it is today? Certainly. We are not going to shy away from that. But that is a trade for the short term, and we are perfectly willing to take this short term pain for a long-term gain. And we think investors with a long-term time horizon should take advantage of headline weakness to add or initiate to a position in a leading financial institution levered to the long term trend of growth in emerging markets at a very attractive price.