Why Citigroup Could Make You Rich
Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors know that to generate alpha one must constantly seek out new opportunities and new ways of looking at the same things. Alpha can be created by capitalizing on public information that other investors can't easily process (think footnotes of a 10-K), building a better mousetrap (think a better trading or valuation model ), achieving a better understanding of how the market works (an in-depth understanding of the company and its drivers), or exploiting structural impediments of the market (think cross-methodological work and post-earnings drift). In this article I will explain what is happening with Citigroup (NYSE: C) and my opinion about the stock.
First, I feel confident from Citigroup's strategy of emerging markets growth. As we can see in the chart, emergin markets are poised for future growth and that will be a medium and long term positive for Citi.
In fact, when I analyze Citigroup revenue by region, only 50% comes from developed markets. This shows that Citigroup has a diverse business model with a significant portion of the revenue being generated from outside the U.S. It has a global footprint with operations in over 160 countries and jurisdictions helping its corporate clients and consumers with their local and global needs. Considering the slowdown in developed markets, Citigroup is emphasizing on growth in the international markets. It is making every effort to expand and tap opportunities in the emerging markets, which are expected to experience a quicker pace of GDP growth than their developed counterparts.
Citicorp, Citi´s core business, has reported consistent revenues despite the financial turmoil in the past few years. Going forward, the company intends to capitalize on the enormous strength of this franchise, once the ongoing de-leveraging is accomplished.
Citigroup has decided to focus on its core consumer banking business after suffering severe losses during the sub-prime crisis. This move also came about due to pressure from the U.S. government, which has a significant stake in the company. The consumer banking business earned a net interest margin of just above 3% in 2011 on an asset base of $482 billion. In comparison, the company had assets worth $130 billion from Transaction Services & Trade Finance in 2011. As the company focuses more on the consumer banking business we expect solid asset growth.
Citi also reported a total of $409 billion in consumer loans and $246 billion in corporate loans at the end of the quarter. While this represents a 2% decline in consumer loans, it also represents a 6% growth in corporate loans for an overall 1% growth in the loan portfolio over the previous quarter. International exposure has been a major concern and in the short term it is definitely a headwind. However, for those investors with a longer-term five- to 10-year outlook, the stock could be a buy at these levels as analysts see a large opportunity for great returns.
In fact, I expect that the company´s earnings start normalizing after 2012 and as soon as that happens, the market could create a fast uptrend in the shares, as happened with homebuilder stocks in the middle of 2011.
Citigroup is among the best reserved banks and management did a very good job at reducing risk. The company's firm-wide allowances are sufficient for covering anticipated future losses. The credit quality metrics also continued to improve during the first half of 2012. Going forward, the company is expected to benefit from an overall improvement in credit quality, given the current economic environment as well as a reduction in overall problem assets, particularly at Citi Holdings.
As we can see in the chart, Citigroup reported an increase in its estimated Basel III Tier 1 common ratio, which now stands at 7.9%. I think the combination of retained earnings (Citigroup has generated more than $5.8 billion in net income so far in 2012) and a shrinking balance sheet will ensure that Citigroup is able to meet a 9.5% Tier 1 common standard in relatively short order.
Citigroup finished Q2 with Tier 1 ratios up compared to a year ago, indicating that while business has been slower, the company is making progress on reducing its risk. The Tier 1 common ratio was 12.7% and the Tier 1 capital ratio was 14.4%. When I compare Citigroup to its banking peers Wells Fargo (NYSE: WFC), JPMorgan (NYSE: JPM), Bank of America (NYSE: BAC) and Morgan Stanley (NYSE: MS), Citi appears as one of the banks with the best financial metrics and business metrics, considering the bank has 28% of international deposits over its assets versus an average of 8% from its US peers.
In terms of valuation, I think that shares are cheap. Citigroup reported the book value of its equity at $62.61 and its tangible book value per share at $51.81. If the market becomes confident that Citigroup's book is fairly safe, the stock has a lot of room to rise from its current price of about $29.50. Citigroup shares currently trade at 7x analysts consensus 2012 earnings estimate, a 35% discount to the industry average. On a price-to-book basis, the shares trade at 40% discount to the industry average. I think that some prominent hedge fund managers agree on that. For example in the last quarter Eton Park, Goldman Sachs, Appaloosa and Maverick Capital increased or initiated their Citigroup position.
What about the risks?
I think that the risks are concentrated in 3 categories:
- Erratic top and bottom line: Although Citigroup's underlying franchises of the consumer businesses have remained strong, revenues have continuously been under pressure for the past several quarters. Any substantial growth in the top line is expected to remain limited in the upcoming quarters. This is one of the facts that explain why shares are undervalued.
- Regulatory risks: Given its scale of business worldwide, Citigroup continues to be subject to a significant number of new regulatory requirements and changes from numerous sources in both the U.S. and in the international markets.
- Macro risks: the overall macro environment could easily deteriorate and make things difficult to the companies in the banking sector.
I think that Citi is a very interesting trade for long term investors. I would like to see some relative strength in the shares before I hit the buy button. As I always recommend in Warren-Trades newsletter, it is essential to buy a solid undervalued stock as soon as it starts performing better than the general market, a strong evidence that institutional funds are buying the shares. I think that Citigroup could trade at $60 in the medium term and investors who catches that trend early could experience material wealth in its portfolios.
markadams12 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.