Citigroup: Buffett’s Recent High Yield Investment; Potential Buy (NYSE:C) – Seeking Alpha

Among the largest U.S. banks, Citigroup Inc. (NYSE:C) has by far the most extensive global reach. Unfortunately, the bank has not translated that advantage into market-beating returns. Citigroup’s stock routinely lags rivals by a significant margin, and this translates into a lagging share valuation.

The KBW Bank Index follows the 24 banking stocks of the biggest U.S. national money centers, regional banks and thrift institutions. In 2021, the index was up about 35%.

Citigroup’s stock fell 1.9% in that time frame.

Furthermore, in 2020, the firm aroused the wrath of the federal government. However, the row with regulators prompted the CEO to opt for an early retirement, and his successor initiated a wide-ranging plan to address the company’s weaknesses and accentuate the bank’s strengths.

Don’t Fight With The Feds

Roughly two years ago, Citigroup was fined $400 million by the Office of the Comptroller of the Currency for its failure to address long-standing systemic issues. Most of the problems were related to the bank’s internal controls over data, compliance, and risk management. Some of those deficiencies were first brought to light in consent orders dating back to 2013 and 2015.

An egregious example of the bank’s shortcomings made the news when Citigroup accidentally wired $900 million to several of Revlon Inc’s (REV) lenders. Management blamed the blunder on a “clerical error” and “out-of-date” software.

Some of Revlon’s creditors fought in court to keep the payments, and the bank was out $500 million following court proceedings that resulted in a ruling by a U.S. District Court Judge. A change in CEOs occurred shortly thereafter, and Jane Fraser, the current Chief Executive Officer, launched initiatives designed to strengthen the company.

CEO Fraser’s “Strategy Refresh”

Fraser became the CEO of Citigroup in March of 2021. Her plans to correct the bank’s aforementioned deficiencies and boost returns is referred to by management as a strategy refresh. Fraser is increasing investments in divisions that currently generate good returns as well as capital-light businesses like wealth management.

Within weeks of taking the company’s reins, the new CEO announced plans to sell the firm’s consumer banking franchises in 14 global markets. Those businesses collectively broke even in 2020, lagging Citigroup’s consumer banking division’s overall results.

Investors can use Citigroup’s efficiency ratio to understand the gap in the firm’s overall performance and to evaluate the businesses management targeted for divestiture. The efficiency ratio is calculated by dividing a bank’s expenses by its net revenues and is expressed as a percentage. Consequently, a lower number represents a more profitable operation.

The 14 markets Fraser targeted are Australia, Bahrain, China, India, Indonesia, Korea, Malaysia, Mexico, the Philippines, Poland, Russia, Taiwan, Thailand, and Vietnam. As a group, they had an aggregate efficiency ratio of 77%. Citigroup’s overall consumer banking business has a ratio of 57%.

When the Banamex operations are excluded, the remaining 13 franchises reported aggregate net income of negative $82 million in 2020 and $354 million in 2021.

To date, Citigroup has announced the sale or winding down of 10 of the units. Most of the transactions should close this year, freeing roughly $4 billion in capital.

Although it will exit consumer banking in those nations, Citigroup will continue with its corporate lending, markets, securities services and investment banking operations. Management expects to free up $12 billion in capital by exiting the targeted businesses and also reduce loan-related risk-weighted assets by at least $70 billion.

One operation that stands out above the others is Banamex, Citigroup’s Mexican franchise. In 2021, Citibanamex generated $4.7 billion in revenue and $1.1 billion in net income, the equivalent of 5% of Citigroup’s profits that fiscal year.

We took a clinical look at our franchise in Mexico, and we drew the hard conclusion that the noninstitutional businesses do not fit our new strategic direction. Now to be clear, these are terrific, they’re scaled, high returning franchises. But our strategic goal is to invest in businesses that are fully aligned with our core strengths and to simplify our firm.

Jane Fraser, CEO

Analysts value Banamex in a range of $4 to $8 billion. Furthermore, selling the franchise would free up $4 billion in capital. Unlike the other businesses targeted for divestment, it will likely take years before a deal for Banamex is consummated.

The divestments will result in Citigroup centering its consumer banking presence around four wealth centers: London, Singapore, Hong Kong, and the United Arab Emirates, as well as its main franchises in the U.S. and Mexico.

While the long-term effects of Fraser’s plan to exit the 14 franchises is likely to prove positive, the bank’s recent results reflect expenses related to the strategy refresh, including divestiture costs.

Our results include expenses of $13.5 billion, an increase of 18% versus the prior year. Excluding the Asia divestiture cost, expenses would have increased by 8%.

Mark Mason, CFO

The increased expenses associated with the strategy refresh, as well as the revenue losses related to the divestitures, will affect the firm’s results for a number of quarters.

Total expenses increased 9% in 2021. Management guides for a 7% to 8% increase in 2022, excluding the toll taken by divestiture costs.

How C Compares With Rivals

Return on tangible common equity (ROTCE) is a standard measure of a bank’s profitability. In fact, when perusing Citigroup’s earnings reports, it is common for management to note the bank’s ROTCE for a given year and/or quarter. It measures the profit on shareholder’s capital, excluding goodwill, intangible assets, and preferred equity.

From 2017 through the end of 2021, Citigroup’s average ROTCE was 10.2%, well below the peer average of approximately 13%. However, during the company’s recent Investor Day presentation, management guided for an 11% to 12% ROTCE over the medium-term, along with a 4% to 5% CAGR in revenue. Assuming management meets its goal, Citigroup’s profitability will show a marked improvement. Even so, it will continue to lag that of competitors.

Where the company outperforms rivals is in its treasury and trade solutions (TTS) business, where it holds the leading market share. Approximately half of the bank’s total deposits are garnered by TTS, and in 2021, TTS generated $9.2 billion in revenue. The bank also holds the number two position in the fixed income markets and among U.S. branded cards.

However, where Citigroup really caught my attention is in its current valuation. As of the end of March, C had a tangible book value (TBV) per share of $79.03. That means the stock is trading for just a bit over 60% of its TBV. To place that in perspective, JPMorgan (JPM) and Bank of America (BAC) recently traded at about 200% of TBV.

Citigroup’s Regulatory Capital Position

Returns at banks are limited by regulatory capital requirements. Consequently, the common equity tier 1 (CET1) capital ratio is followed by investors and regulators alike, and for good reason. CET1 measures a bank’s core capital expressed as a percentage of risk-weighted assets RWAs.

I’ll not meander too deep into the weeds on this one, but suffice it to say that the Federal Reserve requires banks to maintain a certain CET1 ratio. Failure to maintain a sufficient CET1 ratio would limit a bank’s ability to pay dividends and engage in share repurchases.

During Q1 earnings call, management announced its intent to push the bank’s CET1 ratio up from 11.4% to 12%, requiring an additional $7 to $8 billion in capital to be set aside. Management also stated share repurchases would be restrained until the company reaches the targeted CET1 level.

Russia

Citigroup disclosed that it had roughly $10 billion of exposure in Russia, and that the bank could suffer as much as $4 billion in losses in a worst-case scenario. However, investors should note that this sum represented only 0.3% of the bank’s total asset exposure in 2021.

Fraser had plans to exit Russia prior to the onset of the war with Ukraine. The question now is whether the company can sell its Russian assets or whether it must simply wind down those operations. If the latter path is taken, it would lead to a write down.

Citigroup Stock – Dividend And Valuation

Citigroup has a current yield of 4.10%, a payout ratio of 24.09%, and a 5-year dividend growth rate of just over 26%.

While the dividend appears safe, and there is room for continued growth, management has made it clear that the bank will opt to direct excess cash to share repurchases.

…I would lean in on a point we’ve had to make a number of times now, which is given where we’re trading, it makes a lot of sense to be doing buybacks. And so we will likely continue to lean that way as opposed to doing a lot to change the dividend. But stay tuned as the capital planning continues to evolve.

Mark Mason, CFO

And right now, particularly given where the stock is trading, buybacks are a very, very important and probably top of the stack for us action that we take. So no, we’re very clear in terms of the importance of giving our shareholders back our excess capital.

Jane Fraser, CEO

This is due to the fact that the shares are currently trading well below tangible book value.

Citigroup currently trades for $48.87 per share. The 12-month average price target of the 13 analysts covering the stock is $70.48. The price target of the 2 analysts that rated C following the last earnings report is $85.50.

C trades for a forward P/E of 7.35x, well below the stock’s 5-year average P/E of 10.27x.

Is Citigroup Stock A Buy, Hold Or Sell?

Citigroup has a global presence that is unmatched by U.S. rivals. The bank has operations in more than 160 countries and jurisdictions. That wide geographic reach provides an advantage when competing for the business of companies with cross-border needs; however, that also comes with a price. The bank must meet regulatory issues that vary from country to country, an often expensive and complicated endeavor.

Furthermore, Fraser’s strategy refresh will take years to play out. Management projects it will take three to five years for the initiatives to bear fruit. It would be reasonable to assume that the road forward will at the very least have an occasional pothole.

However, when considering an investment in Citigroup, I cannot dismiss the stock’s current valuation. Suffice it to say that it is rare to find a company trading nearly 40% below tangible book value. Then consider that the bank has a safe dividend yielding of 4.2%. The phrase, “getting paid to wait” immediately comes to mind.

If your goal is to invest in one of the most profitable banks, or a business with a deep moat, Citigroup is not on that list.

If you seek a stock trading at a bargain basement price, with a high yield, and good free cash flow, C is well worth considering.

With the latter thought in mind, I rate Citigroup as a BUY.

I caution investors that the strategy refresh will take years to play out, and the path forward will likely come with a number of setbacks. However, C is currently trading well below Berkshire’s (BRK.A) (BRK.B) average cost per share of roughly $53.40. Assuming Warren Buffett has it right, an investment here should provide good long-term results.

I will add that Citigroup is unlikely to increase the dividend by more than a token amount for the foreseeable future. However, management has emphasized that capital will be devoted to share buyback programs to take advantage of the stock’s current valuation.

Source: seekingalpha.com