This week’s announcement by Citigroup's management to enact a 1-10 reverse stock split could in fact be the bellwether of growth for one of the most scarred banks of the financial crisis.
Citi's over levered balance sheet and portfolio of toxic agreements with insolvent counterparties was what led the financial giant to the brink of bankruptcy. Vikram Pandit's firm barely weathered the storm, and after a 90% decline in share price from just five years ago, Citi is now a compelling buy for any value investor and here's why...
Out with bad in with the good. Citigroup is divided into Citicorp (Consumer Banking and Institutional Clients group) and Citi Holdings (Asset Management and Lending). Much of the firm's plight was due to the latter, Citi Holdings. It has been a sore on the company’s books and one of the biggest hurdles to overcome since the trough of the financial crisis. In 2010 however, Citi Holdings represented just 19% of Citigroup as compared with 38% in 2008. Through successful divestments of Smith Barney and other asset sales and pay downs, Citigroup is getting back to its core competency and growing on the Citicorp business. Its consumer units in the emerging markets, notably Latin America and Asia, will be the biggest stimuli for long-term growth.
Contrarian belief on financial services. Buy low and sell high is a common saying in investing that often goes ignored, in practice. In fact, buy low and sell high could be more easily understood as "buy into fear and sell into greed." What we have seen since the collapse of Bear and Lehman, is a market driven by fear. Of the 10 sectors, financial services were, and continue to be, the most oversold. It is trading at a deep discount when compared to the overall market and unless you believe that sector is eternally doomed, it is certainly ripe for a buy. Citi is trading at a Price/Book of 1x and has a Price/Sales of 1.2x. JP Morgan, perhaps Citi's closest peer is trading at Price/Book 1.6x and has Price/Sales of 1.6x. Additionally, Citi is trading at 12x earnings and with an improving balance sheet and an undervalued sector, it seems to be among the most appealing of the large bank stocks.
Throw the technicals out the window. Say goodbye to Citi's $3-5 eternal trading window! Day after day, Citi was top of the charts in terms of trading volume. Traders have been playing volatility to make money on Citigroup, at the expense of the stock price and the small time non-institutional shareholder. The more they trade in terms of share volume, the greater discounts they receive from the brokerage houses. In turn, actively driving up or down the price just a few cents could prove to be quite lucrative for those opportunistic volatility traders. With a price in the $40 (post-split) range, these volatility traders will look elsewhere and Citi will begin to trade on its fundamentals once again.
There are certainly other reasons why Citi is a compelling buy, such as the peak in delinquencies which will only rebound, the introduction of a dividend, the improvement of net interest margins and strengthening credit conditions (but these have/are being priced into the markets already). But for those investors who are not out to make a quick buck off of volatility, perhaps Citi is worth another look.
Disclosure: Long Citi, no position in JP Morgan. I do not represent my employer and my opinions may not neccessarily be their own. My comments and opinions are strictly based on public information and I do not have any privied information on anything I comment on.