Citigroup: Bulls In Charge, But Obstacles Still Exist

Summary

• Recent company headlines have stoked optimism and brought renewed attention to Citigroup.
• Better dividends and substantial stock buybacks will continue to support the long-term outlook.
• Investors must remain aware of certain macro factors that could change the outlook and derail the current rally before the end of this year.

Some of the biggest financial media headlines of the last several weeks have been generated by Citigroup Inc. (NYSE:NYSE:C), which recently surprised markets when the company boosted dividends and stock buybacks in ways that surprised most of the analyst community. The market response has been strong, with the stock moving to long-term highs near $70 per share. But while this is clearly good news for the stock, there are still potential obstacles that could stall gains in the second half of this year. Here, we will look at some of the factors that could reverse portions of the current optimism levels if certain scenarios ultimately come to fruition at the macro level.

Now that Citigroup has passed its recent stress tests, the bank is in a position to return roughly $19 billion in capital to shareholders. Share buybacks will account for 83% of this figure, so it is clear that Citigroup significantly favors buybacks over dividends. The sheer size of these numbers does go far to explain the major rallies that can be viewed in the context of the five-year chart shown above. But there is still potential for all of this enthusiasm to start to unravel if we see revised interest rate expectations at the Federal Reserve.

One of the most worrisome issues with all of the recent news is the fact that Citigroup is now scheduled to pay out much more than the bank is expected to earn over the next year. The revenue outlook could further deteriorate if voting members at the Fed start to backtrack and suggest that previous concerns over possible consumer inflation trends are no longer valid. The combined effect here could be a stock selloff (or at least a round of profit-taking) if investors lack the confidence to suggest markets will see a real turnaround in Citigroup’s lagging stock performance.

In the chart graphic above, we can see that the strong trends seen previously in the US consumer inflation data have already started to show signs of stalling. This type of economic activity can have a drastic impact in the ways the Fed views its consumer responsibilities, so investors could be forced to face a more volatile outlook for the stock if interest rate expectations are altered. One area that could produce this type of change can be found in energy markets, where massive multi-year declines in WTI crude can reduce inflationary pressures for both consumer groups and several important industry sectors at the producer level.

Even with these potential negatives, bulls remain in charge with respect to Citigroup stock. Markets have pushed forcefully through prior double-top resistance at $62.20, and the bias remains positive as long as this level remains intact. We should expect some retracements here given the fact that the CCI reading is overextended to the topside. But the fact that Citigroup is in a position to double its quarterly dividend is clearly going to be something that continues to attract the attention of the investment markets. From a comparative standpoint, Citigroup still has one of the most attractive valuations in the banking sector with the company trading at a discount of more than 10%. This puts Citigroup in a favorable position relative to blue-chip competitors like Bank of America Corp. (NYSE: BAC) and JPMorgan Chase (NYSE:JPM), which both trade at a premium using the same metrics. This is also why the share buybacks suggest the potential for such a strong strategy, as Citigroup will be adding $1 in book value for every 90 cents paid through buybacks. This will go far in reversing the massive problems that were encountered during the global financial crisis, and so investors will need to view these factors within the context of a macro outlook at the Federal Reserve that could potentially see alterations in the second half of this year.

Analyst’s 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.