Analyzing Citigroup's Worth

| About: Citigroup Inc. (C)
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Belief that credit quality at the largest lending institutions is improving continues to gather adherents. As bank balance sheets heal from their near mortal wounds it is time to look ahead and ask how much these banks can earn so investors can determine how much a share of stock is worth. In this regard it seems appropriate to focus on Citigroup (NYSE:C) since it came so close to financial death, has a unique worldwide franchise, and did not acquire other troubled institutions during the financial meltdown.

Credit quality is clearly improving at Citigroup as evidenced by the fact that non-accrual assets at the end of 2010 were 37% ($12.2 billion) lower than they had been at year-end 2009. This improvement helped Citigroup report net income of $10.6 billion for 2010 versus a loss of $1.6 billion in 2009.

Citigroup's board recently approved a base salary of $1.75 million for CEO Vikram Pandit. Pandit had vowed in 2009 to receive an annual salary of $1 until Citigroup returned to sustained profitability. This recent board action is therefore particulary interesting.
Given the implied belief that sustained profitability has returned at Citigroup, investors now need to ask how much Citigroup can be expected to earn going forward and how much of a dividend will it pay to shareholders. Future earnings and dividends will largely dictate price movements in C.

An appropriate way to determine future earnings is to focus on a bank’s return on total assets (ROA). This measure has always been a generally accepted, standard metric used to compare the relative profitability of banks. For example, high-earning banks typically earn more than 2% on their assets, while low-earning banks earn less than 1%.

The SEC filings of Citigroup during the relatively halcyon period from 1997 through 2006 revealed that its ROA ranged from a low of 0.79% in 1998 to a high of 1.66% in 2005. Its average ROA for that decade was 1.33%. Its dividend payout during this same time period ranged from a low of 13.98% of net income in 1997 to a high of 48.19% in 2004. Its average dividend payout from 1997 through 2006 was 27.95%.

At the end of 2010 Citigroup reported total assets of $1.915 trillion, more than 12% below its 2008 asset peak of $2.187 trillion, but up slightly from the end of 2009. It is likely that Citigroup is in the early stages of expanding its asset base; however, its rate of asset growth should not be expected to equal or exceed the 8.09% annual average achieved from 1997 through 2006 when its total assets grew from $680 billion to $1.484 trillion.

In a book I wrote for the American Bankers Association titled, "Asset/Liability Management," I noted that high-earning banks had higher earning power ratios, which I defined as the ratio of interest earning assets divided by interest paying liabilities (EA/PL). Other things being equal, the bank with the highest earning power will be more profitable as measured by ROA.

A particularly healthy sign at Citigroup is the fact that its earning power is once again rising. From 1997 through 2010 Citigroup’s earning power (EA/PL) ranged from a high of 125.18% in 1999 to a low of 107.88% in 2008. Importantly, Citigroup’s earning power reached 113.59% in the fourth quarter of 2010, which is the highest reading since 2000. The recent increase in this important predictor of bank income reflects improving credit quality at Citigroup as loans return to accrual and the continued jettisoning of non-earning assets.

A conservative forecast using the above data suggests that Citigroup’s total assets can be expected to grow by 6% per year. Its ROA in 2010 was about 0.50%. Accordingly, it is reasonable to expect that Citigroup’s ROA should return to the 1% area in the near future and that it could comfortably payout 20% of net income in common stock dividends.

The application of these assumptions yields earnings per share for Citigroup of about $0.66 per share for 2011 and a dividend of about $0.12. By 2015 earnings per share should reach $0.85 and dividends $0.17.

At a current price of $4.82, Citigroup shares are valued at 7.3 times expected 2011 earnings and 5.7 times 2015 earnings. By comparison the S & P 500 and KBW bank indexes are both trading around 15 times earnings.

This brief analysis suggests that a significant increase in Citigroup’s stock price is possible as the turnaround at Citigroup gathers momentum and it returns to financial health. A doubling in the current price of C would put its price earnings multiple on par with other large corporations in its peer group and should not be ruled out.