If someone offered to sell you a business for $1 million and the land value alone was worth $2 million, I am sure you would consider taking the offer. The market gives us opportunities like this, but it gives them when there exists so much uncertainty. This is why I really like the financials right now. The market has discounted them heavily because of the global economy. Many believe that the big banks such as Bank of America (BAC), Citigroup (C), and JP Morgan (JPM) have significant exposure to Europe. Economists are predicting a double dip because of stagnant job growth. The U.S. government nearly defaulted and the Federal Reserve has vowed to keep interest rates extremely low for at least two more years. So with so much uncertainty and pessimism in the world, why should we even consider purchasing these financials? Well, because of this negativity, the market has priced these companies at a steep discount.
I believe Citigroup is a clear double bagger, possibly a triple. This would be long-term of course. Let's start digging through the company and see why it is so undervalued.
Citigroup's balance sheet shows that it has $138 billion in net tangible assets. Now the market cap of the company is only $84 billion. So the discount to its physical value is 40%. Why such a steep valuation? Let's go over the reasons why the market may be discounting the company so heavily:
- Citigroup may not be profitable going forward
- Citigroup's assets may be not be worth what's stated on the balance sheet and may need to be revised downward
- A double-dip would cause the mortgage market and unemployment market to decline substantially
- U.S. banks may be too exposed to European banks or debt-laden nations such as Greece
Let's first address Citigroup's profitability. Unlike its peers such as Bank of America, Citigroup has bounced back pretty quickly from its massive loss in 2009.
It seems the market sentiment is Citi's asset values will decrease over time. Just the opposite is currently happening; the company's assets are increasing. Hypothetically speaking, let's say Citigroup's assets should be restated, even still the company is aggressively paying down debt and deleveraging itself. The net tangible assets will still continue to grow.
Regarding a double dip and the European credit crisis: Even if a double dip were to happen, Citigroup's exposure to the mortgage market is less and their leverage is much lower than when the financial crisis occurred. In terms of European exposure, Citi is not that exposed. They have $13 billion in loans in Europe, however, only $1 billion of that is in countries like Greece, Ireland, Portugal, and Spain. Keep in mind, these are secured loans.
Even assuming European nations default and all these loans are wiped out (very unlikely even in a default), Citigroup is still being priced at a high discount.
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The segment that experienced the largest loss in 2008 was the institutional clients group. Vikram Pandit has publicly stated that this segment's losses are decreasing because of stringent credit requirements and increase in corporate loans.
Citigroup is a stock that is being priced as if there is going to be another recession much worse than we are in now. The company is profitable, asset values are increasing, leverage is decreasing, and credit costs are low. I honestly believe that when confidence in the financial sector strengthens, Citigroup will run. The company is strong, but unfortunately is being grouped with underperforming banks such as Bank of America.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.