By Matt Doiron
In July, billionaire Bill Ackman wrote to investors in Pershing Square Capital Management that it had sold all of its shares of Citigroup Inc. (C) and used the capital to take a position in The Procter & Gamble Company (PG). Pershing Square had begun carrying out this plan during the second quarter of 2012 - at the end of June it only owned 1.1 million shares of Citigroup, down from 26 million at the beginning of April, and has initiated a position of 22 million shares in Procter & Gamble.
At the time, we didn't think that this was a good substitution, concluding that Ackman was likely expecting a global recession (in which case a consumer staples business would be an obvious pick over a financial stock) but that even low to moderate growth would lead to a rebound at Citigroup. Since the news of Ackman's sale of Citigroup Inc. broke on July 12, the stock is up 33%; since the end of June, it is up 23%; since the middle of the second quarter, it is up 21%. The Procter & Gamble Company? Up 8% since July 12, 13% since the end of June, and up 8% since the middle of the second quarter. Even if P&G is credited for its larger dividend yield (3.2% on an annual basis) its returns have fallen well short of Citi's. True, Pershing Square has taken less risk in the process - Ackman specifically referred to problems in the financial sector, which emphasized that one bad event could cause large declines in Citi's stock price, and actually still thought the bank was cheap - but at this point the trade looks like a loss.
Even after the gains in its share price, Citigroup Inc. still trades at only half the book value of its equity. It probably does warrant a discount to book value, but joins its peer Bank of America Corp (BAC) as likely still being priced too low in terms of book value (Bank of America trades at about 40% of book value). In terms of forward earnings Citigroup is clearly cheaper than its peers, with its P/E multiple of 7 comparing favorably with Bank of America's 10 and JPMorgan Chase & Co.'s (JPM) 8. JPMorgan Chase also trades much closer to the book value of its equity, at a P/B of 0.8. Admittedly Citigroup is losing revenue and earnings, with both down in its most recent quarter compared with a year ago, and JPMorgan Chase is in the same boat as well. Still, we actually like all three of these banks at their current prices, as they are considerably cheaper than others in the industry. Andreas Halvorsen's Viking Global increased its stake in Citigroup during the second quarter to a total of 8.4 million shares.
Procter & Gamble's revenue was about flat last quarter compared with the same period in the previous year, but earnings surged 45%. The company now trades at 19 times trailing earnings; even with the dividend yield, and taking into account that the stock's beta of 0.3 limits an investor's downside, this suggests that the market is pricing in high growth in the future. The forward P/E is 16, which would represent something pretty close to what we think would be fair value if the company can hit that target. Warren Buffett's Berkshire Hathaway (BRK.A) was a major shareholder at Procter & Gamble at the end of June, though the holding company did sell shares during the second quarter. The Procter & Gamble Company is best compared with Johnson & Johnson (JNJ), which saw a large decline in its earnings in the second quarter versus Q2 2011and now trades at 22 times trailing earnings. The sell-side expects a return to normalcy, and the forward P/E of 13 beats Procter & Gamble's (again, assuming the company can meet expectations). The 3.5% dividend yield is also about in line with its peer. Even after the recent rise in financial stocks, we would prefer any of the three banks - including Citigroup - to either of these companies.