Citigroup: Why Its Stock Could 8x (NYSE:C)

A Look At North America’s Largest Banks

Over the past three years, investors have picked winners and losers when it comes to North America’s largest banks. Canadian banks have outperformed, and global banks like Citigroup (NYSE:C) have underperformed:

The contrarian in me tells me the world is long the wrong banks. You see, bank earnings are notoriously cyclical, and those who are taking on the greatest risk often sport the greatest earnings. As Warren Buffett once said:

“Only when the tide goes out do you discover who’s been swimming naked”

Buffett’s been selling high P/B banks like U.S. Bancorp (USB) and buying low P/B banks like Citigroup of late. There is an enormous gap in the price to tangible book ratios of Citi and its peers:

At the same time, I believe Citigroup has both a stronger balance sheet and less loan risk than its peers. Let’s take a look:

Lehman Brothers (2007)	3.3%	2.9%
Financial Institution	Equity To Assets (%)	Cash & Equivalents To Assets (%)
Citigroup (C)	8.4%	27.2%
JPMorgan Chase (JPM)	7.6%	25.1%
Bank of America (BAC)	8.8%	15.9%
Wells Fargo (WFC)	9.5%	11.8%
Royal Bank of Canada (RY)	5.6%	26.8%
Toronto-Dominion Bank (TD)	5.8%	16.0%

Click to enlarge

• Chart uses total equity and includes ‘federal funds sold’ in cash & equivalents.

In the above chart, higher percentages generally mean better balance sheet safety. Banks that have more reserves and higher amounts of equity compared to assets are less likely to blow up. Citigroup is cashed up with a very conservative balance sheet, whereas a bank like Toronto-Dominion Bank carries more balance sheet risk. The extreme example is Lehman Brothers (seen at the bottom), which went bankrupt in 2008.

In summary, Citigroup is both cheaper than its peers and better capitalized.

A Visa Like Moat

Citigroup’s crown jewel is its Institutional Clients Group (ICG) segment. This is Citi’s corporate bank, which, in 2021, accounted for more than 70% of the bank’s post-tax operating income.

In October, Seeking Alpha’s very own IP Banking Research wrote that the Institutional Clients Group segment is generating a “mid-teens” ROE and is estimated to be worth $150 billion. As for the moat, IP said:

“The fixed costs and investments in people, systems, technology, controls, legal and compliance, and banking licenses across over 90 jurisdictions are almost impossible to replicate.”

When I heard this, I immediately thought of Visa (V), which is known for its massive network, connecting banks and merchants on a global basis. Networks like these can generate very high returns on capital and Citi’s profitability in this segment should only increase with time.

The Loan Exposure

Above are the loans in Citi’s two main segments, ICG and Personal Banking & Wealth Management. As you can see, Citi’s largest exposures are in U.S. credit cards, global corporate loans, institutional services, and high net-worth individuals.

The balance sheets of global corporations and high net-worth individuals are generally very strong. The only significant risk I see in Citi’s loan portfolio is its credit card segment. This doesn’t worry me much as the high interest rates on credit cards often offset the risk, and Citi has a ton of experience in this form of lending. American consumers are still in better shape than many:

Household Debt To GDP

On the back of a tremendous bull market in global housing, some regions have entered bubble territory:

Thankfully, Citigroup has very little exposure to mortgage debt, especially when compared to its peers.

Expenses And Catalysts

Citi is selling its least profitable assets, as well as transforming its existing business. As Citi sells off its global banks, it’s incurring a lot of expenses related to the transactions. Improving the existing business also comes with costs. Because other banks are not following in Citi’s footsteps, they’ve outperformed in the short term. But, these are temporary expenses for Citigroup.

There are a few huge catalysts for Citi’s outperformance:

• Temporary expenses related to Citi’s transformation will eventually fade.
• Citi may begin to reverse its provisions for credit losses.
• Share buybacks will eventually resume and could be very powerful at less than 0.5x book.
• Mr. Market may re-rate Citi’s increasingly profitable business. The new and improved company will be concentrated in low-risk areas where Citi has a competitive advantage.

Risks

The market often has a one-year time horizon and appears to be forecasting more short-term pain for Citi. If Citigroup sells assets at a loss, it will have to report these losses in its earnings. If this were to happen, it could artificially reduce Citi’s earnings. With an inverted yield curve, a recession may be around the corner. Investors must be patient and focus on Citi’s tangible book value until this all blows over.

Long-term Returns

Citi is cheap, even by its standards:

If the company were to trade at 2x book again one day, you could garner an enormous return. But, here’s my conservative valuation:

My 2033 price target for Citigroup is $152 per share, implying returns of 16% per annum with dividends reinvested.

• I believe Citigroup can grow its $179.5 billion of common equity at 2% per annum. It’s also conservative to assume that Citi can buy back shares at a rate of 3% per annum. In this scenario, Citi’s $93 of book value per share becomes $152 by 2033. I assumed a terminal multiple of 1x book.

If Citi were to trade at 2x book by 2033, you could get a total return of nearly 800% (An 8x return).

In Conclusion

Value investing is all about low-risk, high-return. Citigroup is the perfect value investment because it carries a strong balance sheet, a durable moat (in ICG), low-risk loans, and tremendous upside. Trading at a huge discount to peers, due to temporary expenses, Citi seems like a no brainer to outperform. If Citi trades at 1x book in 10 years, it could 4x. If it trades at 2x book, as it did for much of the 2000s, it could nearly 8x. Despite this, investors must keep in mind where we are in the macro cycle and be prepared for non-cash headwinds as Citi divests global assets. We recently sold JPMorgan Chase to double down on Citi. Will you be making the switch?

Until next time, happy investing.