Citigroup: Hold Or Fold?

| About: Citigroup Inc. (C)
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Q3 earnings are out.

I discuss the key metrics and address noticeable concerns.

Comes down to performance versus expectations.

I first got behind Citigroup (NYSE:C) in the summer of 2012 at $26.28 per share. It delivered a double since then after I said it looked like a good investment for the next 3-5 years, but the stock has steadily pulled back from its highs of over $60 and has stagnated under $50 for some time. It is well into bear territory. Now despite this fact, longer term, I have maintained a hold rating because I am of the opinion that all bank stocks will start to move higher and will benefit from higher interest rates. We got our first raise from the Fed late last year, and another raise is imminent. But has there been an impact in any way?

Well, Q3 earnings were just announced. The bank delivered a top line and bottom line beat against analyst estimates. I will say plainly that this quarter was decent, but expectations were pretty conservative. Revenue was, however, down markedly year over year. Revenue came in at $17.76 billion and was down 4.0% year over year. Now, this was a strong beat of $420 million over estimates. It is important to note that the company also saw a worsening on the earnings front versus last year's comparable quarter. Adjusted net income was $3.8 billion which translated to $1.24 in earnings per share. This was a sizable beat of $0.08, but be mindful that this is down in a pretty strong way from the $4.3 billion or $1.35 per share seen last year. Quite unfortunate.

Now, the headline numbers are important, but we need to realize why numbers were down. Revenues were down from currency issues, a minor slip in Citicorp core revenue as well as a 48% decrease in Citi Holdings. Further, net income decreased 11% driven by the lower revenues and a high tax rate, partially offset by lower cost of credit and reduced operating expenses. I think there is something to be said about operating expenses dropping by a nice 2% year over year. This was in large part due to its cost savings initiatives and lower legal expenses. They came in at $10.4 billion. Clearly, the company is moving in the right direction for this important metric. Of course, when looking at revenues and expenses, we should look to the efficiency ratio. Well, I will tell you that the biggest piece of positive news out of this quarter was the improved efficiency ratio. The company is spending wisely as it has an efficiency ratio that is among the best-of-the-best. It remains under 60% and boasts one of the best ratios of the large banks that I have covered. The ideal is 50%, with strong banks around 60%.

What about loans and deposits? Well, Citigroup's loans were $638 billion in total to end Q3 2016. This is up 1% quarter over quarter, and 2% (currency adjusted) year over year. Total average deposits rose year over year. Total average deposits were $940 billion in Q2 2016. This is up 4% in constant dollars over last year. It is also up from the $938 billion to end Q2 2016 so there is some growth this quarter. But you should be aware that Citicorp deposits jumped by 5% overall, but the strong 37% decline in Citi Holdings deposits weighed. As you can see, Citi Holdings is still weighing on the company, but this divestment is nearly done. And so I think investors need to really be focused on the growth from Citicorp as the company moves out of Citi Holdings. As I have said several times, Citi Holdings is to blame for a chunk of weakness, but overall this was still a decent quarter despite the low expectations. I feel under $50 a share the stock is attractive long term, but would strongly prefer if you waited to get shares under $45. The P/E ratio is a reasonable 10.1, which is well below the sector average of 13-14 times current earnings. Further, the dividend, while low, could be raised into the future to put the bank on par with its competitors. On top of that, book value and tangible book value both rose this quarter, up 8% each. With the stock in neutral, the discount to tangible book becomes compelling.

So what is the take home? Even in this low rate environment the company continues to deliver against expectations, even if they are pretty low. Investing is about performance relative to the expectations set. I like that book value is improving, and the discount to tangible book is attractive. I can't imagine what earnings will look like when the company can start making loans at a higher rate and widening its margins. Once Citi Holdings is behind the company I think we will see operating expenses further firm up. Finally, it continue to rate the name a hold. This is because when rates move up, banks do stand to gain. Although the bull market is aging, I think large financials have better days ahead.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.