Pgiam/iStock via Getty Images
Citigroup (NYSE:C) is a deeply undervalued U.S. bank that has unmatched scale in facilitating international transactions for multinational corporations. The stock has traded terribly for 15 years, getting butchered with every global macro scare that has popped up. While the bank’s returns lag its peers, the bank has been a consistent grower of tangible book value per share. The current discount provides an outstanding opportunity for the long-term investor, with well over 50% upside within 18-24 months.
I’d argue that the biggest catalyst for the recent plunge in stock price is exposure to Russia and macro fears. Citigroup has total net investment exposure of about $9.8B, including Russian entities that are outside the country, according to management at the investor day earlier in March. Its direct exposure to Russia is less than $1B. Management forecasted that under a severe stress scenario, the bank’s loss could be roughly $5B. Knowing the quality of Citigroup’s multinational clients, I’d expect losses in Russia to be far lower than the worst-case scenario, but certainly there is risk there. The bank is now planning on exiting Russia, where it had been operating since the 1990s.
The Russian/Ukraine conflict and the scorched-earth sanctions policy implemented by the West are pouring gasoline on an already out of control inflation fire. Going into 2022, the Consumer was in exceptional shape, bolstered by stimulus and savings from the pandemic. Unemployment remains low and wages have been growing. However, the steep rise in energy, food, rent, etc., is now starting to add significant pressure and growth estimates are declining. Various parts of the yield curve are pointing towards a potential recession, which frankly would not surprise me whatsoever. The supply chain nightmare is not improving, especially with the latest Chinese lockdowns.
There are a lot of reasons to be pessimistic given the environment I’ve laid out. With that said, price is what you pay, and value is what you get. At a recent price of $52.33, the stock trades at just 66% of its tangible book value per share of $79.16. The average ROTCE over the last 5 years has been 10.2%. The average earnings per share over the last 5 years have been just under $7. The bank ended the 4th quarter with a CET1 ratio of 12.2% and a Total Capital Ratio of 16%. These are on the high side of where they have been, and liquidity is ample.
New management is focused on divesting non-core international consumer banking operations, which have historically generated low returns, and where Citigroup is not the most efficient operator given capital and regulatory requirements. The company plans to redeploy assets into Wealth Management and its core franchises, including Treasury and Trade Solutions, where the bank is a leader. Bears have focused on the fact that expense growth is going to be exceeding revenue growth this year and probably next year as well, as Citigroup realigns its business structure, including dealing with the Consent Orders that must be dealt with.
While I applaud the fact that management is taking decisive steps, which probably should have been made a decade ago, I don’t think they have done a good job in expressing a desire to also focus on maximizing shareholder value. The reality is that there is nothing that management can spend money on that will create more value than stock buybacks at the current price. Management had an issue in the 4th quarter where they had to halt buybacks, and while they have been buying stock in Q1, there are concerns that they might not be able to do much more in 2022 depending on how things develop. This will be an important thing to watch when the company reports Q1 earnings. Certainly, the bank can’t skimp on any regulatory spending, but I believe retaining flexibility and clear communication is important for long suffering shareholders. These types of selloffs can be huge opportunities to create value, but frankly, management has already botched it by somehow being the only big U.S. bank that couldn’t keep buying back stock in the 4th quarter, and the trust is simply not there right now.
While all the focus is on the negatives, there are some positives, including the fact we have already seen one rate hike and prospects are very good that we will see quite a few more this year. A concurrent 100-basis point increase in both short- and long-term rates, would add a couple billion into net interest revenue. Credit card spending has been extremely robust, but the healthy consumers have been paying off their bills more quickly than usual. That trend seems unlikely to last as outrageously high gas prices, etc. are likely to cause higher loan balances. I love the focus on wealth management, which brings high return and low capital insensitivity revenues into the fold. The investment banking businesses have been outstanding during the last few years, but the current macro trauma is likely to cause a bit of a dip in the short term.
When a bank is this cheap, there are a few questions that must be asked. Is it solvent? Without question, Citigroup has some of the highest capital and liquidity ratios in its history. The bank will be nicely profitable, even if we do indeed see a recession this year. Is the business model broken? While there certainly are some structural flaws within the organization that lead to suboptimal returns, I’m encouraged by the aggressive strategy to focus on the higher returning portions of the business. These moves will free up capital, ultimately setting the stage for more capital returns. Citigroup has averaged a greater than 10% ROTCE in this low interest rate environment, so I think the bank can support a valuation of around tangible book value per share, which keeps growing. There is the potential for robust growth in this metric if management can attain $10B or so of buybacks with prices this insanely cheap. The point I’m trying to make is that there is a balance between investing for the long term and being opportunistic when the stock is being sold for 60 cents on the dollar.
I think most analysts believed the stock would rally after the investor day in early March, but management’s tone was quite passive in relation to buybacks, and in my opinion, was inflexible about the level of spending. The stock sold off hard, which should be a bit of a message to this new management team that their message is not landing with investors. It is great to spend money, but let’s not forget that the money belongs to shareholders. As a long-term investor, I want to see money allocated to the area where it has the highest ROI and least execution risk, which at this stage is clearly buying back the stock. Citigroup has generally been a good buy at this valuation, while a terrible buy at close to tangible book value. Until management durably closes the returns gap with peers, it’s tough to imagine the stock trading at a sustained premium to book value, but that still leaves plenty of room for upside. The current dividend of about 3.8% looks quite secure and provides a nice yield while one waits for capital gains. The company will report 1st quarter results in a few weeks, where I’ll plan on providing updated numbers and assumptions. The most important thing will be the communication from management to Wall Street. We want to see flexibility and a sense of urgency in maximizing both business and shareholder value.
Be the first to comment