Citigroup: Taking A Page From Tech, Realignment Can Unlock Value (NYSE:C)

Citigroup Inc. (NYSE:C) announced this week a major organizational realignment. The biggest change is a flattened leadership with the elimination of several management layers intended to speed up the decision-making process and streamline the overall business.

Beyond the buzzwords, the effort here is to kickstart growth, improve returns, and ultimately reward shareholders. Citigroup has underperformed its Wall Street peers, and the understanding is that changes are necessary.

We’re looking at C as a potential turnaround opportunity. Recognizing the volatile macro backdrop, we believe that the steps are going in the right direction, which will result in lower costs and higher margins.

This is a strategy that has proven successful for major technology names in 2023 that we believe can work for Citigroup to unlock value. Shares continue to trade at a depressed valuation, representing an opportunity, in our view, ahead of a repricing higher.

Citi is Simplifying Its Operating Model

Citigroup’s strategy move is intended to shift the overall business towards higher value-added segments like services, commercial banking, and wealth management. This is in contrast to the company’s traditional focus on personal banking with a heavy presence on the retail side.

On this point, the bank has exited certain country-specific consumer franchises and is consolidating its entire business outside of North America under a single leadership unit. The expectation is to generate synergies to be captured over several years going forward.

A big theme right now is investments being made on the technology side, which has resulted in some higher near-term spending. These steps are to create a more secure infrastructure, improve employee productivity, and enhance the client experience.

The goal is to push the return on average tangible common equity (RoTCE) towards a target of 11-12%, which compares to 8.7% in the most recent reported Q2. This would be achieved with a top-line momentum of 4-5% average annual revenue growth while optimizing its risk-weighted asset mix.

C Financial Recap

The story this year for Citigroup has been dealing with the challenging operating environment, alongside most other mega-cap investment banks. Compared to a boom in financial services during the pandemic through 2021, there has been a generalized slowdown, particularly in areas like investment banking and weaker lending.

In Q3, even as net interest income climbed by 16% year-over-year, capturing a benefit from higher rates, this was overshadowed by a -28% drop in non-interest revenue. At the same time, a 9% increase in expense, reflecting the infrastructure investments and restructuring charges, resulted in a drop in operating income with EPS down 39% from Q2 2023.

At face value, the headline metrics here are poor but keep in mind that many of these themes are sector-wide trends. Everything from the deal volume, advisory services, and capital markets have been weak in 2023 globally while Citi’s results also include the impact of various exits and wind-downs from exiting certain businesses during this restructuring.

There were some strong points, personal banking franchise led growth with momentum in credit cards. The wealth management business saw an increase in total client assets. Corporate client flows have also been solid. The message from management during the earnings conference call is that the underlying business is on a firm footing.

What’s Next For Citigroup?

Looking ahead, it’s clear that Citigroup remains exposed to the economic environment. While recent data has shown relative strength in the U.S. in terms of consumer spending and even at the GDP level, the understanding is that tight financial conditions and high-interest rates will continue to weigh on the credit side.

We can take an optimistic view, and envision a scenario as part of the bullish case for the stock where the operating environment turns stronger than expected. The potential that inflation favorably cools lower, opening the door for the Fed to cut rates into 2024, could lead to a renewed growth cycle Citigroup would be well positioned to capture.

At that same time, we believe it’s more important to focus on the factors that are more directly under Citigroup’s control. In this case, the efforts at expense reduction will play a big role in supporting return ratios and driving profitability.

One of the actions being announced alongside the corporate realignment is a move to reduce 15% of “functional” roles which can be interpreted as middle management employees. By exiting several international consumer businesses, including the planned IPO of the Mexico “Banamex” operation, the sense is that the initiatives are now picking up speed.

In the near term, upcoming milestones include closing the Indonesia operation and accelerating wind-downs through the year-end. The latest update is that management plans to offer a revised reporting structure including a comparable historical presentation by the Q4 report.

By this measure, investors can think of this current 2023 year as something of a transitional period that is laying the foundation for stronger performance going forward.

In our view, the bar of expectations for Citigroup into next year is otherwise low. According to consensus, the forecast is for 2024 EPS of $6.19, up 7% year over year. This would be achieved on top of just a 1% higher revenue growth estimate.

The potential is that pending 2024 guidance from management will surprise the market with both faster-than-expected expense reductions and stronger growth targets could work as a powerful catalyst for the stock.

C Stock Price Forecast

What we like about Citigroup is that the stock has more to gain from its potential strategic turnaround compared to a bank like JPMorgan Chase & Co. (JPM) which is already recognized for its “fortress balances sheet” and rock-solid fundamentals.

This becomes evident when we compare Citigroup to peers like JPM and Bank of America Corp. (BAC), along with Wells Fargo & Co (WFC). C trades at a deep discount across most metrics including a price-to-book value of 0.4x, well below the measure closer to 1x for BAC and WFC. JPM commands an even larger premium, trading at 1.5x.

Some structural differences warrant the spreads including each bank’s positioning on the investment banking side and higher margin lending products. That said, if Citigroup is successful with its restructuring, we see room for its spread to at least narrow over time.

Investors acknowledging the potential with room for the macro side to cooperate will find some attractive value in shares of C here, which currently yield 5% on a forward basis, well above its peers yielding closer to 3%.

Looking at the stock price chart, it’s encouraging to see shares of C have bounced off a near 52-week low, suggesting improved bullish sentiment on the heels of the latest announcements. We see room for that momentum to continue.

We rate C as a buy with a price target of $52.00 taking it back to a level shares traded as recently as Q1. This target implies a price-to-book level closer to 0.5x as closer to fair value, in the current circumstance. Longer-term, shares would have even more upside as earnings accelerate allowing for some measure of multiples-expansion. With the dividend yield, the return potential is 25%.

In terms of risks, we already mentioned the macro uncertainties and volatile interest rate environment. Monitoring points for the company over the next few quarters include the trends in the ROTCE and the efficiency ratio as a measure of the execution of its strategy goals.

Final Thoughts

The title of this article alludes to a connection we’re making with Citigroup focusing on cutting expenses with a theme this year in the technology sector where companies took similar steps at expense reduction.

Many high-profile market leaders announced widespread layoffs as a measure to streamline their operations. Meta Platforms Inc (META) CEO Mark Zuckerberg, for example, famously called 2023 “The Year of Efficiency“. Those steps are one reason tech stock prices have performed so well this year.

We believe Citigroup can benefit from that same playbook going forward. The company has had its challenges, but can emerge stronger in our opinion which should be positive for the stock price.

Source: seekingalpha.com