Costco Card Move Makes Citigroup A Buy

| About: Citigroup Inc. (C)

Summary

Citigroup will start processing Costco credit cards in June.

The new card's terms should bring additional business with it.

If this gets the stock back to book value, it's a 33% gain.

For the last year, investors looking at Costco (NASDAQ:COST) have mainly been obsessed over the negative impact of its credit card move on American Express (NYSE:AXP).

Now that the files have been transferred, and new cards are in the mail, they should be looking instead at the impact on the winner, Citigroup (NYSE:C).

The new Citigroup Costco card will have rewards comparable with the best cards in the industry from Capital One (NYSE:COF). These include 3% on travel, 2% on all Costco purchases, and 1% on all other purchases.

This could have a huge impact on the "share of wallet" the new card enjoys, and the visibility that data gives Costco on its customers, most of whom are middle-to-high income (so they can afford the space to store what they buy). The old Costco card was mainly a store card. The new one could easily become a family's primary card. The difference for a family earning $150,000/year could be as much as $3,000/month flowing through the new card in preference to other cards.

Now, multiply that estimated spending by 32 million, a recent estimate of Costco's U.S. membership, and we're talking quadrupling the amount of cash flowing through the cards from the AXP figure. Profit margins on credit may be wafer-thin, and Costco members may pay off their cards every month, but we're probably talking about at least $4 billion flowing to Citi over the course of a year. This one move could mean a 25% gain on earnings each quarter, starting in July.

While investors have been shunning Citigroup's stock for years, and it has the lowest price-to-book ratio of any of the big banks at .64, it is the only one of those banks that offered a credible "living will" break-up plan in the government's recent test. It has been rapidly building capital, which should enable large buybacks of stock in the future assuming the government decides to allow it. The stock has rallied from the mid-30s in February to the mid-40s after earnings, so someone is noticing.

Citigroup could simply book those new Costco profits or it could invest some in advertising and in building its credit card market share. Citibank was the fourth-leading credit brand with a turnover of $194 billion. As previously indicated, the Costco deal could put it on top, taking out AXP at $519 billion and passing JPMorgan Chase's (NYSE:JPM) $370 billion. Citi's share of outstanding balances was also under 10% at the end of 2014, and that should also be rising.

So what you have is an undervalued bank, one the government could let fail, gaining a huge book of business that should be profitable, and with a management eager to share gains with shareholders in order to get the stock value past book.

If that's not the best buy among the big banks, I don't know what is.

Disclosure: I am/we are long COST.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.