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Citigroup Has 100% Upside Potential

August 02, 2012 | About:
Established in 1812, Citigroup (C) is one of the oldest financial services providers in the world. It serves nearly 200 million customers around the globe and has its presence in 160 countries. The company operates in the financial services sector under the banking industry. Employing around 266,000 staffs as on December 2011, it is celebrating 200 years of being in the business of banking. Citigroup is commonly known as Citi, and the main focus of Citi is to concentrate on its core banking operations. Likewise, Citi is segmented into two divisions, namely Citicorp and Citi Holdings. It serves consumers, both individual and institutional customers through global consumer banking and institutional clients group.

Brief history

Charles Prince stepped out of Citigroup on November 2007, and he was temporarily replaced by Robert Rubin until Dec. 11, 2007. Vikram Pandit became the CEO of the Citigroup on Dec. 11, 2007 just before the financial crisis started to unfold. The real problem started during the second half of 2007, and this was clearly reflected in the third-quarter results. It recorded a loss of $3.3 billion due to sub-prime mortgage problems. The share prices were dipping drastically, and shareholders were losing their confidence in the stock performance. Subsequently, the shareholders began selling their shares pushing the prices even lower, making it difficult for the company to recover. As a corrective action, Citi laid off 52,000 employees in 2008 and was followed by a loss of $30 billion. The Federal government provided a bailout package of $45 billion and provided guarantees for nearly $306 billion of toxic assets. However, $20 billion was repaid later through a public offering of 5.4 billion ordinary shares in 2009.

Citigroup had a market capital of $147 billion at the end of 2007, and its share price was $294.40 on a split adjusted basis. The market capital further declined to $5 billion on March 5, 2009 and later rose to the range of $110 billion to $145 billion. However, the share prices didn't rise to the extent of increase in the market capital. Following the various secondary offerings made by the Citigroup, the ownership of shareholders was diluted by about 80%. The company strengthened its capital position by approximately 270% during the third quarter of 2009 as against the last quarter of 2008. It reduced the expenses by $15 billion annually and sold $281 billion worth of non-core assets in Citi Holdings.

Competitors' Analysis

The major competitors of the Citigroup are JPMorgan Chase (JPM) and Bank of America (BAC), and they too are struggling to recover from the financial turmoil. Citi, along with JPMorgan and Bank of America, are struggling with the negative quarterly revenue growths (year over year) of 2%, 12% and 14%, respectively.

The profit margin of JPMorgan (17.7%) exceeds the industry average of 11.1%. The P/E and P/S of 7.2 and 1.4 are below their industry averages. The second quarter result of JPMorgan has been impressive with drastic increase in earnings. The reported EPS for the second quarter of $1.21 is almost 60% more than the last quarter.

Bank of America needs to improve on the operating margin, which is currently 11% and reflecting a negative EPS of 0.13. PEG (five-year expected) is estimated as 1.74 which is higher when compared with the industry average of 1.07. The stock is currently trading at $7.04 with a 52-week range of $4.91-10.09.

Recent performance

Citigroup stock is currently at $25.24 with a 52-week of $21.38-40.04. The share price had hit an all-time low of $10.30 in March 2009. Vikram Pandit, the current CEO also plans to increase investments in emerging markets as they account for the major portion of bank's profits. The Board rejected the payment of bonus to Vikram Pandit considering the bank's future performance. MSN money estimates that the industry and company sales are growing at the rate of 1.9% and -8.4%, respectively.

Financials

The company has converted a loss of $1.6 billion to a positive net income of $11.1 billion over a span of 2 years. Tier 1 capital ratio and common ratio increased by 0.7% and 1% over the last year. The stock is quite cheap for its size with a reputable price-to earnings ratio of 6.9, and a price-to book value of 0.4. When compared with peers and the industry average, these ratios are below the industry average. Net borrowings have declined by 6% from $89.422 billion to $83.916 billion. Citigroup holds $808.6 billion in cash with an operating margin of 18.6%. Debt-to equity ratio is 1.7, below the industry average of 1.9. The net profit margin has increased from 13.3% in 2010 to 4.8%. Based on its numbers, Citigroup has a B Grade O-Metrix score of 7.12. (For more information on O-Metrix calculations, please click here.)

After reviewing the second quarter results of 2012, I am sure that the cost cutting strategy has helped Citi in its recovery. This particularly holds good for the investment banking division of Citicorp, where it reduced the expenses by $322 million and increased the net income by 18%. EPS reflected $0.95 per share, which was above expectations. Operating expenses fell by 6% and share price rose by 0.60% to reach $26.81. The net income dropped by 12% from the previous year's quarter. However, this fall can be attributed to the decline in revenue from the Citi holdings, the bundle of troubled assets. It was confirmed by the CEO that core banking businesses are doing well and are generating good returns.

Summary

In my opinion, recent quarterly results were impressive compared with the previous quarterly ones. Q2 results were encouraging in terms of EPS, standing above the expectations and losses mainly coming from the troubled assets. Improving capital position is a major plus for the company with declining toxic assets. Trend of stock prices is upward moving, and it is slowly getting rid of Citi Holding’s toxic assets. Vikram Pandit is planning to expand in the emerging markets like Brazil, China and India. Citi already has a strong international presence in the developing nations and was able to add high- margin loans to its balance sheet. This has given the Citi a competitive advantage over peers in the industry.

Citibank is a good investment in the long-term as the shrinking asset base of Citi holdings’ toxic assets will improve their valuation over the years. This would help the company regain its lost market share, along with the confidence of its shareholders. The stock is currently trading at premium post the announcement of the quarterly results and reflects the sentiments of the market. The price ratios and strengthening capital base make it an effective buy for the long run. I believe that Citigroup will hit its highest peak with continuous recovery strategies and strong capital base. This is one stock that has the potential to double within this year or so.

About the author:

ogulsev
Efsinvestment.com website offers simple do-it-yourself type of investment ideas. You can download excel files that can easily calculate the Fair Value of a stock, along with O-Metrix score and Margin of Safety.

Investment philosophy is to first determine the maximum loss, and invest accordingly. Like many value investors, we prefer to invest in stocks with the highest dividend yields, and highest EPS growth potentials. Telecommunication and energy stocks in emerging markets are among the favorites.

Based on extensive quantitative analysis, in any market, going short is risky. Statistical analysis shows that technical indicators work only if they are strong enough to convince the majority of the investors. Do not buy a stock at the top, do not sell a stock at the dip.

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