Prior to 1st quarter earnings, I wrote about Citigroup (NYSE:C) and specifically mentioned that management should be as aggressive as possible with stock buybacks given the valuation. While I’m fully supportive of the restructuring, I’ve felt that management had been too flippant about the value of stock buybacks, which simply make too much sense to ignore at the massive discount to tangible book value per share the stock trades at. I feel like the company responded positively and then we got further good news about Berkshire Hathaway establishing a sizeable stake in the company. I understand that pessimism is pervasive, but I believe investors with a long-term time horizon will be richly rewarded by investing in Citigroup.
New CEO Jane Fraser established a clear plan as she took over for Michael Corbat, who in my opinion, did a solid job stabilizing the company. She is investing heavily into meeting the regulatory orders, divesting non-core international retail banking assets, and putting a major emphasis on growing the wealth management business. The reality is that in today’s regulatory environment, being a global retail bank is far less attractive than it was prior to the Financial Crisis. Citigroup’s bread and butter is still its workhorse Institutional Client Group, which provides a comprehensive assortment of products and services for multinational corporations. These are usually companies with strong credit quality and operations that truly span across the globe, where Citigroup’s wide footprint is a major benefit.
The company has announced new agreements to sell a further 7 consumer businesses in Asia and EMEA, the most recent being India and Bahrain. The largest sales process relates to the Mexican consumer franchise where it is a leading player, so an announcement on that at a favorable price could be very favorable for the stock. The company is retaining its institutional presence to serve those multinationals, but divesting the consumer parts, so it is more complicated than most deals where you are only selling a business. Deals in China, Poland, and Russia will likely take a bit more time due to geopolitics.
The bear case against Citigroup is that the bank has generated a lower ROTCE than its peers over the last decade and the gap is not likely to close in the next year or so, as the company invests heavily to fundamentally change the business. These short-term concerns are what create the opportunity to buy a dollar for 60 cents, for those willing to think longer-term, as I believe a 12-15% normalized ROTCE will eventually be attainable. In addition, there are major and valid concerns that we are on the precipice of a recession, which could cause enhanced loan losses. These are legitimate issues, but the price you pay is as important as any other factor in investing, and the math is simply too good to ignore when it comes to Citigroup. The company is conservatively reserved under CECL accounting rules where the bank immediately reserves for all expected future loan losses under various scenarios.
Citigroup reported a very respectable 1st quarter with revenue of $19.2B, down 2% YoY. Net income was $4.3B, down 46% with less loan loss releases, and EPS was $2.02, down 44%. The company reported a solid ROTCE of 10.5%, which would have been 150 bps better had it not been for the impact of divestitures. The CET1 Ratio was 11.4%, down from 12.2%, as higher interest rates reduced the AOCI. The goal is to get back to 12% by the end of the year, which could limit buybacks a bit in the 2nd quarter, but it should be manageable to have a balance between growing capital and shareholder returns. The bank has levers it can pull from net income generation, DTA utilizations and capital generated from the sale of businesses. Total expenses of $13.2B increased 15% or 10% excluding the Asia divestiture-related impacts. 3% of the increase in expenses was driven by business-led investments including the hiring of commercial/investment bankers, and client advisors. These also include major technology investments as the company is trying to digitize many of its trading operations. 1% was due to higher revenue and volume expenses, mostly in markets and cards. Roughly 4% was driven by inflation, which is pressuring everyone, but at least banks can offset a lot of that with higher net interest income over time.
Cost of credit was $755MM, with net credit losses of $872MM partially offset by a net ACL release. Embedded in the net ACL release is a Russia-related build of approximately $1.9B. This includes $1B related to exposure to Russia and about $900MM to account for the broader impact on the macro environment. Citigroup’s remaining exposure to Russia stood at $7.8B, down from $9.8B at year end. Direct Russia country risk exposure has dropped from $5.4B to $3.7B, which consists of loans, AFS, derivatives and off-balance sheet exposure. The remaining exposure of about $4.1B consists of deposits and cash with the Central Bank, reverse repos, and cross-border exposure. The net investment in the C’s Russian entity is down to $700MM. The company believes under a range of severe stress scenarios that the potential risk of loss is approximately $2.5-3B, which is truthfully quite manageable for the company. As of the end of Q1, Citigroup has $17.9B in total reserves, with a reserve to funded loan ratio of 2.35%, which to me still seems quite conservative with just how good credit has been, baking in plenty of room for future deterioration.
Tangible book value per share ended at $79.03, up 5% YoY. Citigroup had better results from many of its peers in not seeing a significant decline in TBV due to higher rates, since Citigroup was able to buy stock at such a massive discount to TBV, which is highly accretive. Not all stock buybacks are the same and there is a big difference between Citigroup buying its stock at 65% of TBV and another bank buying back stock at 2x TBV. In total, the company returned $4B to common shareholders in the quarter through a combination of buybacks and dividends. Citigroup has reduced common shares by about 6% over the last year.
Treasury Trade and Solutions (TTS) saw revenue grow by 18% YoY, due to fee growth, cross-border transactions, and higher rates. Security Services also saw revenues grow by 6% despite weaker markets YoY. ICG revenues decreased by 2%, mostly due to Investment Banking having a tougher time, as capital markets really froze up in March with the onset of the Russia/Ukraine war. Net income in ICG was $2.6B for an ROTCE of 11.2%. In Personal Banking and Wealth Management, revenues declined 1% as net interest income growth was more than offset by lower non-interest revenue. Credit card revenues declined by 1% due to higher average payment rates and acquisition/rewards costs, but there are signs of major improvements. New accounts were up 24%, as were card spending volumes, while average loans were up 7%. Citigroup has a $2.4 trillion balance sheet, including about $551B or 23%, of high-quality liquid assets. Total liquidity resources are approximately $960B.
Warren Buffett’s 1984 speech The Superinvestors of Graham-and-Doddsville has always stuck with me. In the speech, Buffett mentions that in 1973, Mr. Market was offering to sell the Washington Post for $80MM, but any one of ten buyers would have purchased all the Post’s assets for at least $400MM. These types of opportunities arise in the stock market due to the short-term nature of most market participants. Most are focused on the next quarter or two, as opposed to truly focusing on what is this business worth, and what am I being asked to pay for it? As someone that has followed banks closely for two decades, it is blatantly obvious that the intrinsic value of Citigroup is at a minimum 50% higher than the current share price. That would still put the stock at a discount to tangible book value per share, which should continue to grow at a good pace.
On May 17th, it was announced that Berkshire Hathaway had built a nearly $3B stake in Citigroup, adding more than 55MM shares. The size of the stake would make me think it was Buffett behind the decision, but regardless, both Combs and Weschler are extremely smart investors as well. The investment makes a lot of sense as Buffett knows banking like the back of his hand. I’d speculate that Berkshire likes the decisions to divest the global consumer businesses and focus on its core operations. The undervaluation is clear, and Citigroup is sizeable enough that Berkshire could allocate $10B or so if they wish, which is important if they want to really move the needle for their mammoth operation. That would give Berkshire nearly 10% of the company. Berkshire has a long history investing in banks and for the most part it avoided Citigroup, instead opting for Wells Fargo, Bank of America, and Goldman Sachs mostly, in prior years. I think Berkshire coming in and buying the common stock adds some level of validation to the CEO’s strategy, and I think they will be richly rewarded over the long-term for doing so.
At a recent price of $49.97, Citigroup trades at only 63% of tangible book value per share of $79.03. Citigroup has averaged $6.34 per share in earnings over the last 3 years, which includes of course the 2020 nightmare. This means Citi’s P/E is only 7.8x its average earnings over the last 3 years, and I’d expect earnings to exceed that average in 2022 bolstered by higher rates. Capital markets are weaker than the bonanza years of 2021 and 2020, but higher rates and credit card loan growth are going to be major catalysts for earnings growth. If the company can balance its capital ratios and continue buying stock while it trades so cheaply, there is a huge opportunity to build value. I believe Citigroup is conservatively worth $80 per share with room to grow beyond that.
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