Citigroup Break-Up Analysis - Part II

After looking over Citigroup (C)'s net income by segment over the last four years (see prior post), it's time to make some projections about the future profitability of the company. First, I am going to do an extremely conservative valuation to try and find out what our likely downside is with the stock. Clearly, these are simply educated guesses at this point, so they could prove way off base.
Nonetheless, if I make a point to be both very conservative and realistic, it will likely be a valuable exercise. As Citigroup reports future earnings (first quarter numbers are due in April), I can see how the projections are holding up and make adjustments if needed.
Sticking with the conservative view, I am going to use a price-earnings ratio of 10x for each of Citigroup's businesses. One can certainly argue that some divisions are worth more than that, but I'll factor that into my more aggressive valuation model later on. For now, conservatism means 10x earnings.
As you saw from Citigroup's historical net income data, two of the four divisions are much easier to predict than the other two. Both the international retail banking operation and the global wealth management business don't see much volatility in earnings. Let's project those two areas first.

International Retail Banking:
Net Income in millions of USD (2004-2007): $3880, $4098, $4017, $4193
Conservative estimate going forward: $4000

Assuming no growth, since recent years have hovered around this level.

Global Wealth Management:

Net Income in millions of USD (2004-2007): $1209, $1244, $1444, $1974
Conservative estimate going forward: $2000

New assets coming in, coupled with population growth, make this area a fairly consistent grower.

The next two areas are far more volatile, but again, I'll try and be overly conservative:

U.S. Retail Banking:
Net Income in millions of USD (2004-2007): $8010, $7173, $8390, $4108
Conservative estimate going forward: $3000

Although 2007 was really ugly, let's assume things get worse before they get better.


Corporate/Investment Banking & Alternative Investments:

Net Income in millions of USD (2004-2007): $2810, $8332, $8403, ($4581)
Conservative estimate going forward: $2000

This is the toughest to estimate. Let's assume the structured finance boom days are over, go back to the 2004 number and slash that by another 30% or so.


Where does this leave us?
If these profit estimates are met, and Citi trades at a 10 P/E, the company is worth about $110 billion. Based on their share count of 4,995 million I get a fair value of $22 per share. The stock currently trades at $25 so we have about 10% of downside to my conservative estimates.

This is why I am starting to be intrigued by Citigroup as an investment in the mid to low 20's. The odds of somewhat limited downside (and tremendous upside) look pretty good. In coming days I'll post a more aggressive (but reasonable) set of assumptions so we can try and see what the upside is if Citigroup rebounds nicely in coming quarters and years.

Full Disclosure: No position in Citigroup at the time of writing.

Comments

[BookValue]

Valuing Citi at a 10x P/E on trough earnings is--to put it politely yet emphatically--absurd.

Historically, Citi trades at 2x the end of year book value, something that is easily verifiable. This is completely appropriate for a company that earns a high teens/low 20s return on equity.

Backing in to what the market is currently saying about the end of year book value will be, we get $62.5B. Make whatever further writedown assumptions you want, but Citi's shareholder equity at the end of the year is not going to be anywhere close to that low, especially when you consider net income in a normal year can hit $20B.

Consensus book value per share for the end of the year is $25-$26 (assuming some pretty dire write-downs) implying that Citi will be a $50 stock within a year.

If you have an investing time horizon longer than the lifetime of a fruit fly (meaning you're not at a hedge fund), stop worrying about how low it could trade from here and take the plunge. If it does go down, buy more.

Do the same kind of analysis on AIG, and you'll come out even further ahead because AIG's risk controls far exceed Citi's.