This Bank Is Undervalued!

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Citigroup’s (NYSE: C) third-quarter results have been impressive. The EPS of $1.06 exceeded the consensus mean estimate by 6.9%, while $19.4 billion revenues beat expectations by 1.03%. Their Basel III capital ratios have improved 150 basis points since the start of this year. In this article I’ll share why the bank is expected to outperform some of its peers going forward and why the stock deserves a buy.

Citi’s Financial Health Improving

The bank’s operations are divided into two segments for the purpose of reporting: Citicorp and Citi Holdings. Citigroup’s results year-to-date continued to show strong momentum -- building on revenue and earnings growth in Citicorp as well as a smaller impact from Citi Holdings.

Citi's revenues, net of interest expense, were $14.0 billion in the third quarter, down 33% versus the prior-year period. Excluding CVA/DVA and the loss on Morgan Stanley Smith Barney (MSSB), revenues were $19.4 billion, up 3% from the third quarter of 2011, as revenues in Citicorp rose 5% from the prior-year period while revenues continued to decline in Citi Holdings.

Net interest revenues of $11.9 billion were 2% lower than the prior-year period, largely due to continued declining loan balances in Local Consumer Lending in Citi Holdings and ongoing spread compression in GCB and Transaction Services in Citicorp.

The bank’s core business witnessed modest growth. Their revenue from fixed income trading grew significantly. A similar trend in the fixed income revenues was also witnessed in the results of Goldman Sachs (NYSE: GS) and JPMorgan (NYSE: JPM).

Third-Quarter Earnings Highlights

  • Citicorp revenues grew 3% year-over-year while expenses were flat and credit costs declined. Excluding the impact of loan-loss reserve releases, the core pretax earnings grew 35% to $16 billion. 
  • Net income grew 6% year-over-year to $12.5 billion, even with the loan-loss reserve release which was over 50% smaller than the prior year.
  • In Global Consumer Banking, revenues grew 2% on a reported basis, or 5% in constant dollars, and credit costs continued to improve generating 7% growth in net income. 
  • In Transaction Services, revenues grew 3% year-to-date while expenses declined, generating 4% earnings growth. 
  • In Securities & Banking, revenues grew 6% year-to-date with very strong results in fixed income, while expenses declined 5% versus last year, generating 27% earnings growth. 
  • Citigroup operating expenses decreased 2% versus the prior-year period to $12.2 billion.

This momentum reflects the ongoing transformation of Citigroup as management continues to simplify the business model and allocates available resources on the core Citicorp franchise while winding down Citi Holdings in an economically rational manner. Importantly, they are executing this strategy from a strong financial foundation with among the highest capital ratios in the industry and a highly liquid balance sheet.

Citi’s Capital Position Improving

With the next round of regulatory stress test just around the corner, capital ratio should be considered as the key indicator of a bank’s financial health. Citigroup’s tier 1 capital ratio is 13.9% at the end of the third quarter of the current year. This is compared to 13.6% tier 1 capital ratio for Bank of America (NYSE: BAC). Wells Fargo (NYSE: WFC) has a tier 1 capital ratio of 11.5% at the end of the third quarter of the current year. Citigroup has been able to increase its Tier 1 capital ratio on a consistent basis.

Citi’s Global Presence: An Added Advantage

40% of Citigroup's core revenues actually come from locations where GDP growth is expected to be between 4% and 6%. 22% of its earnings come from Asia, while Goldman Sachs's (NYSE: GS) earnings are 12% reliant on Asia, followed by Bank of America at 10%, Morgan Stanley at 6%, and JPMorgan also at 6%.

Stock Attractively Valued based on PTBV

A stock's price to tangible book value per share or PTBV represents the amount of money an investor would receive for each share if a company were to cease operations and liquidate all of its assets at the value recorded on the company's accounting books. The lower the ratio, the more attractive the stock is from an investment perspective.

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C Price / Tangible Book Value data by YCharts

With a tangible book value per share of $52.84 as of the end of third-quarter of 2012, and a price/tangible book ratio of 0.71, the stock looks reasonably attractive around $37. The consensus mean price target is $42.90.

The Bottom Line

With the economic slowdown around the world showing signs of a smart recovery, Citigroup is well positioned to benefit going forward. I would recommend buying the stock for a significant upside over the medium to long term.

Anindya7 has long positions in Citigroup and Bank of America. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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