Citigroup Inc. (C, Financial), a New York-based global financial services company, offers a wide array of services encompassing consumer banking, credit services, corporate and investment banking, securities brokerage, trade and securities services and wealth management.
Recognized as a significant money center bank, the company's stock has faced downward pressure in light of economic deceleration and underlying inflation-related cost pressures. The company remains strongly capitalized, boasting a Common Equity Tier 1 (CET1) capital ratio of 15%.
The formula for the Tier 1 capital ratio is core equity capital divided by risk-weighted assets. The "Tier 1" name refers to the core equity capital of a banking institution, which includes common stock, retained earnings, disclosed reserves and non-redeemable, non-cumulative preferred stock. In order to attain a top-tier "well capitalized" score, a banking institution must have a Tier 1 capital ratio of at least 6% and meet certain other requirements related to the impact of its dividends and distributions on its capital.
Current stock performance and future strategies
Presently, the stock is trading at a substantial discount compared to its book value and delivers an approximate yield of 4%. As such, I recently increased my holding. As a result of historically disappointing performance over several decades, however, most financial investors do not show much interest in the stock.
In an effort to turn things around, CEO Jane Fraser has been executing sensible strategies, including divesting underperforming consumer divisions and marginal country franchises, enhancing technological and operational foundations and distributing capital to shareholders. As an example, the company is selling off its consumer businesses in Mexico and Asia. These initiatives are expected to drive improvements in equity returns. However, the market response has been rather unenthusiastic as the stock continues to sell at about half of its tangible book value.
Anticipated improvements and returns
Anticipated enhancements in cost efficiency should become evident by late 2024 or early 2025, accompanied by a rise in equity returns. The current stock price stands at around $44.39, representing 52% of its tangible book value of $84.19.
The company expresses confidence in achieving a return on tangible common equity of 11% to 12% by 2025, by which time its tangible book value could exceed $100. Should the company meet its return goal, Citigroup's stock is likely to return to its tangible book value, implying a potential increase of more than twofold over the next few years. Additionally, investors can benefit from the annual dividend of 4.6%, which currently outperforms 10-year Treasuries in terms of yield.
In addition, the three-year average share buyback ratio has been 2.9%. This together with the dividend yield offers shareholders a compelling return.
Global presence and challenges
Citigroup operates internationally with a commercial banking division and a domestically-oriented retail banking segment. The Institutional Clients Group within the commercial operations encompasses trading, investment banking, corporate banking and custody services, setting it apart due to its challenging-to-replicate global presence. This reach benefits the bank in serving companies with international requirements, yet it also poses challenges due to its high costs and complexity, and the markets desk's lower returns.
Consequently, the business' performance has been mixed. Citigroup's other primary division is Personal Banking and Wealth Management, which centers on a U.S.-focused credit card business, complemented by some retail banking and wealth operations. However, this unit's performance has been variable over time as the bank does not hold the same level of dominance or profitability as its peers in retail banking, card services or wealth operations. The legacy franchises are slated to be divested or otherwise closed.
Valuation
In terms of valuation, the discounted cash flow (earnings based) valuation even with a conservative cost of capital (discount rate) of 9% looks compelling.
Further, looking at the 10-year price chart below, I have the following observations. The company is not too far above the lows it printed during the Covid bear market. There also appears to be lingering fears following the banking scare in the U.S. earlier this year. The 10-year median price-earnings and price-book justified prices show a solid margin of safety.
Conclusion
Overall, Citigroup has a solid balance sheet for a bank, the equity is substantially undervalued by at least 40% and pays a stable and growing dividend. It is also buying back stock and is working hard to improve its return on equity.
Another thing to note is that even though Citigroup's tangible book value has steadily increased over the last decade (compound annual growth rate of 4.59%), the stock price has not gone anywhere. Thus, the valuation gap between equity and price continues to widen. Obviously, this cannot go on forever and one day will start to narrow. This makes me think that the stock is like a beach ball being pushed under the surface of the water by Mr. Market and one day its going to spring up rather suddenly.
