This Stock Won't Be This Cheap For Long

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

A few years ago, Citigroup (NYSE: C) seemed like a can't lose proposition. Banks like Citigroup and Bank of America (NYSE: BAC) seemingly could do no wrong. They acquired other institutions, their earnings grew, and so did their dividends. Then the Great Recession hit, and not only did earnings evaporate, but so did their once attractive dividends. Both banks have been through the ringer in the last few years. However, it seems investors are missing the vast improvement in Citigroup's results. This situation reminds me of Peter Lynch's experience with Fannie Mae.

The Block Of Granite
Peter Lynch wrote in his book, “Beating The Street” about his journey with Fannie Mae's stock. He described the transformation from an interest rate cyclical to a growth stock in detail. One phrase he used that described Fannie Mae's old business at the time was the “block of granite.” He said that all of the old loans that Fannie Mae wrote were this “block of granite” and they were hiding the much better returns of the new Fannie Mae. This seems to be exactly what is happening with Citigroup. 

Citigroup is actually two businesses in one. The first is Citigroup, which is growing, reporting good earnings, and stability. The second is Citi Holdings, which is the “old Citigroup” or Citigroup's block of granite if you will. The point is, the new Citigroup is beginning to shine through, and this block of granite is starting to matter less and less.

The Best And Then The Rest
I don't want anyone to misunderstand me here, if you have to choose exposure to just one large bank, I believe it's a neck and neck race between BB&T (NYSE: BBT) and U.S. Bancorp (NYSE: USB). These two banks offer good growth prospects, good organic growth, and great credit quality. Citigroup and Bank of America are both improving their operations, but they aren't at the same level as BB&T or U.S. Bancorp, at least not yet. 

If you want proof that Citigroup is beginning to look like a respectable bank again, look at their organic growth. The lifeblood of any bank is loans and deposits. Citigroup reported an increase of 7% in deposits and 7% in loans in the current quarter. Bank of America reported average deposits up 11%, but the company struggled with consumer real estate loans which were down over 16%. By comparison, the two best banks set the standard for the industry. BB&T reported deposit growth of 8.1% and total loans up 9.3%. U.S. Bancorp showed an increase of 9.2% in deposits and 8.6% in loans. As you can see, BB&T and U.S. Bancorp performed better, but Citigroup is beginning to close the gap.

Hidden Strength
The biggest worry about any bank today is their credit quality. Stalwarts of the industry used to report such a small amount of non-performing loans that it almost wasn't worth mentioning. Today, BB&T's non-performing loans are 1.2% of the portfolio, and U.S. Bancorp's non-performing loans are 1.11%. These figures are still very good relative to companies like Bank of America, which reported non-performers at 2.62%, and Citigroup at 1.95%. However, Citigroup's numbers aren't what they seem at first. 

Citigroup is nice enough to report non-performing assets both with and without Citi Holdings. With Citi Holdings, the non-performing loan percentage is 1.95%. However, without Citi Holdings, this percentage drops to 1.05%. Think about that for a moment, if Citigroup were to somehow extinguish Citi Holdings tomorrow, their non-performing loan percentage would beat both BB&T and U.S. Bancorp.

Will It Grow Again?
Analysts are calling for 11.65% EPS growth from Citigroup over the next five years, and with shares trading at just over 9 times projected earnings, the stock looks like a good value. In fact, on a PEG ratio basis, Citigroup's ratio is 0.78, which is second cheapest to Bank of America at 0.63. Considering BB&T and U.S. Bancorp trade with PEG ratios of 0.95 and 1.18 respectively, you can see that Citigroup could move up quite a bit just to match these two companies. 

Another way to measure Citigroup's value is in comparison to their tangible book value. Since tangible book value strips out things like goodwill, it represents a more accurate picture of the value of the company. At current prices, Citigroup trades at a 16.64% discount to tangible book value. Bank of America trades at a discount to tangible book value of 11.23%. By comparison, BB&T trades for a 75% premium to tangible book value, and U.S. Bancorp trades at an 82% premium to standard book value (U.S. Bancorp did not report tangible book value last quarter). No matter how you slice it, Citigroup appears cheap.

Citigroup's dividend increase is just a matter of time. The bank is making all of the right moves to strengthen its operations and balance sheet. As the Citi Holdings piece of the puzzle gets smaller, a dividend increase should be all but guaranteed. With good organic growth, improved credit quality, and the stock selling at a discount to its peers, this stock won't be this cheap for long.

MHenage has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America and Citigroup Inc . 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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