This is my first article on SA, so I will make this brief and to the point.
The following table compares the earnings, ROTCE, dividends, and valuations (P/E and P/TBV) for various banks:
(Table created from data available from Fidelity Investments)
SP= stock price, TBV = tangible book value, EPS = earnings per share
Several things to note:
- Most of the banks have an ROTCE higher than 10%
- Most of the banks have a dividend yield higher than 2%
- Most of the bank valuations reflect a P/E of 14 - 16
- Most of the bank valuations reflect a P/TBV of 1.25 to 2+ times TBV
- Citigroup Inc. (NYSE:C), however, has a substantially lower ROTCE, substantially lower dividend yield, and trades at a substantially lower P/E and P/TBV
If C were trading at comparable valuations, it would be trading north of $65.
How have investors in these companies done the past year?
- JPMorgan Chase & Co. (JPM) - stock up 17.7% plus another 2.4% in dividends
- Bank of America Corporation (BAC) - stock up 17.7% plus another 1.5% in dividends
- U.S. Bancorp (USB) - stock up 12.2% plus another 2.2% in dividends
- PNC Financial Services Group, Inc. (PNC) - stock up 14.0% plus another 2.0% in dividends
And C?? Stock up a whopping 3.2%!!! The reality is that C's 3.2% appreciation came with a whopping 33% decline earlier this year. It's a high beta risky stock. When valuations are heading back up, shouldn't the high beta (high risk) stock outperform? Apparently not with C. Not to pick at anyone's scabs before they've fully healed, but to get the 3.2% we had to endure a mind numbing drop off a cliff, with very little on the rebound.
C management can fix the dividend disparity. And that will help a lot in my opinion. Once the dividend is raised, and I mean significantly (please get it higher than "no risk" 10 year treasuries for heaven's sake!!!!), income investors will take note.
But can C management do anything about the low ROTCE?
Citigroup ROTCE Expectations
The answer to the question is … not without massive stock buybacks and dividends. So much so, that the total capital return will likely need to exceed 200%.
Here is the model I put together of ROTCE through 2020:
(Table created by author using his own data assumptions)
There are various assumptions in the model you may or may not agree with:
- Income returning to $16B in 2017 (basically what it was in 2015) and then increasing 2% or so each year thereafter.
- No change in preferred dividends from current levels.
- No change in the other factors that can affect TCE such as OCI, employee stock, and non-controlling interests.
- DTA (deferred tax asset) utilization doesn't impede the return of capital shown in the model.
- Dividend payout increasing to 35%.
- Stock price growing to 125% of TBV (mostly on the back on higher dividends).
- Shares bought back at an average of the beginning and ending stock prices, at an amount necessary to raise the total capital payout (including dividends) to 250% by 2020.
What does the model seem to suggest? A couple things:
- ROTCE is not likely to hit 10% without massive buybacks (total capital returns approaching 250% by 2020).
- If management can return that much capital, including raising the dividend payout to 35%, the stock can appreciate nicely (I assumed it would trade up to at least 125% of TBV which is where BAC currently trades).
So … you tell me, can management get to the point where it is returning almost $40B a year by 2020? Can they do it without selling off assets? That's the "denominator problem" in a nutshell.
There has been some debate in multiple SA articles about dividends vs buybacks. What the above makes abundantly clear is that the argument is moot … they need to do both on a massive scale. The denominator problem is not an "either / or" problem. It is an "all hands on deck" problem.
If management can handle this massive capital return challenge and get their ROTCE and dividend yield up, then the stock, if it trades up to 125% of tangible book value as I've assumed in the model, will reward investors nicely. The average annual return over the model period is roughly 15% (not counting dividends).
Citigroup's valuation is at a substantial discount to its peers for many reasons. Two reasons (and not the only reasons) are that it has a much lower dividend yield and a much lower ROTCE. The ROTCE is likely to remain below 10% for some time even if the total capital return (dividends and buybacks) grows to 200%+. Investors are probably pricing that lower ROTCE expectation into the stock.
Citigroup needs to compensate for this going forward by significantly increasing its dividend above its peers. Perhaps "special dividends" may be a way of returning excess capital as well.
Me, myself and I are all very long C and have been for what seems like an eternity.
Disclosure: I am/we are long C.
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.