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Citigroup: On the Road to Recovery
Posted by: Fede Zaldua (IP Logged)
Date: November 20, 2013 05:08PM

Though sluggish, the U.S. economy is going through a sustained recovery phase. Besides, most U.S. government officials and intellectuals who have direct influence on U.S. economic policy - such as Larry Summers - are convinced about the need for continued monetary and fiscal stimulus. Hence, investing in banks with a broad presence in the U.S. should not be a bad idea, above all when valuations still remain under pressure. Among the so-called “too big to fail” U.S. banks, Citigroup (C), which is held by Leon Cooperman and Lee Ainslie, is my favorite one.

Even when other banks have surpassed Citi in terms of profitability or financial strength, the combination of US and Latin American exposure, earnings growth and low market valuation makes Citi a great option when you are looking to gain exposure to large capitalization US banks.

Positive Quarter Despite Weak Earnings

For its third quarter, Citi reported net earnings of $3.2 billion or Earnings Per Share (EPS) of $1, which was just below consensus expectations of $1.02 per share. The bank explained its poor performance through lower than expected earnings at the Institutional Clients Group (ICG) division (mainly trading activities in equities, commodities and fixed income) but also lower Consumer Banking revenues on weaker mortgage results. Its extremely relevant to stress that third quarter ICG and mortgage related results came weaker than expected at most banking institutions, including JP Morgan (JPM) and almighty Goldman Sachs (GS). On my opinion, much more relevant metrics (because they can be more directly affected by management's decisions) such as those metrics related to expenses and credit quality came in line with expectations.

All the above being said, there was one remarkable positive sign of improvement during Citi's third quarter. Citi Holdings assets now represent just 6% of total consolidated assets, versus 9% a year ago. This means that Citi was able to shrink Citi Holdings by as much as $9 billion quarter-over-quarter mainly through $4 billion in asset sales and $5 billion in pay-downs. The bank continues to fix itself and managements seems to be on the right track towards normalization.

An Attractive Relative Valuation.

Citi, which could increase its tangible book value by 3% quarter-over-quarter, is relatively cheap. The bank, which is expected to produce a ROE of 7.35% for the current financial year, trades at 91% its tangible book value and 2014 9.3 times earnings. A comparable bank such as Bank Of America (BAC), which is expected to produce a ROE of 5.43% for the current financial year, sell for 109% its tangible book value and 2014 10.9 times earnings.

Meanwhile, Citi's estimated Basel III Tier 1 common ratio improved by 0.4% quarter-over-quarter to

10.4%. Its relevant to stress how the bank has comfortably surpassed its self-imposed 9.5% milestone – Bank Of America's Basel III Tier 1 common ratio stands at 9.94%.

Bottom Line

Citigroup is following the right steps towards its normalization after the 2008 housing crisis that almost sinks the centenary banking house. I expect the bank to start increasing its dividend yield fast (now at the symbolic level of 0.08%) by mid-2014 and to start trading above its tangible book value in the short term.

Guru Discussed: Lee Ainslie: Current Portfolio, Stock Picks
Stocks Discussed: C, JPM, GS, BAC,
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