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Citigroup On The Mend … Slowly
It's just a fact of life that it's easier and faster to destroy than it is to rebuild. To that end, Citigroup (NYSE:C) has certainly been a frustrating stock to hold this year as the stock had been nearly cut in half before a recent rally. While this huge bank's third quarter earnings continue to point to progress, the reality is that Citigroup is still a long way from normal, and shareholders have to be content with more short-term disappointment if they want to see the long-term value play out.
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Decent Third Quarter Results
Although analysts had been marking down their expectations, going into this quarter, Citi didn't do too badly. Adjusted core revenue fell 2% on a sequential basis, as modest growth in regional consumer banking (2%) and decent growth in transaction services (7%) was offset by declines in securities and banking 12%. For whatever reason, it helps shareholders, this performance is likely to be the rule for other large banks like Bank of America (NYSE:BAC) (BofA) as well.
On a slightly more concerning note, operating expenses were up 8%. Most banks, and particularly those with sizable foreclosure issues like Citi, BofA, Wells Fargo (NYSE:WFC) and so on, are seeing higher expenses as it takes personnel and money to process these matters.
At the end of it all, Citi did slightly beat the analyst expectations for earnings, even after adjusting for a sizable gain from liability re-evaluation. Unfortunately, it looks as though around half of earnings came from further reserve releases, and this should continue to decline as the company's credit profile normalizes.
Where's the OUS Growth?
One concerning detail, of the quarter, was the relatively unimpressive growth in Citi's Latin American and Asian operations. A quick look at the stocks of Korean banks like Shinhan (NYSE:SHG) and KB Financial (NYSE:KB) or Latin American operators like Banco Santander Brasil (NYSE:BSBR), Itau Unibanco (NYSE:ITUB) or Creditcorp (NYSE:BAP) would certainly corroborate the idea that this is no longer a red-hot space. Longer term, this is a good place to be, but it looks like Citi can't count on these regions to speed its recovery.
At the same time, Europe could still be a problem. Citi almost certainly has billions of dollars still at risk in Greece, Portugal and Ireland, to say nothing of the knock-on risks in countries like Spain, France and Germany.
There's the problem, then, with trying to value Citi on its book value - there's a good argument to be made that those loans will take a haircut, and with it the company's equity and book value. This does not mean that the company's capital is in serious peril, but it's a reminder that the trouble isn't over.
Where Does the Bank Go?
One of the issues with Citigroup is that the company's strategic direction is still uncertain. For instance, the company has apparently decided to keep the retail partner cards business - probably not a bad decision given that the bank does not desperately need the capital, and it can be a profitable business in the future. But, this restructuring has cost the bank valuable assets like Smith Barney (which it conveyed to Morgan Stanley (NYSE:MS) in a complex deal), and nobody knows how much more shuffling is left before the bank's management has the hand it wants to play.
The Bottom Line
The story on Citi is the same as it has been for a while now. Assuming that there are no major write offs left to come, and that the bank can eventually regain (and hold) a return on equity of 10% or better, the stock is undervalued - probably close to 50% undervalued. The trouble is, that same argument holds for a lot of banks right now, and it is hard to argue for owning Citi when U.S. Bancorp (NYSE:USB) or PNC (NYSE:PNC) offer pretty solid appreciation potential with a lower risk profile. Still, for those who like to play the deep-value turnarounds, Citi, for all of its problems, is not a bad name to consider. (For additional reading, see Analyzing A Bank's Financial Statements.)
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Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
Decent Third Quarter Results
Although analysts had been marking down their expectations, going into this quarter, Citi didn't do too badly. Adjusted core revenue fell 2% on a sequential basis, as modest growth in regional consumer banking (2%) and decent growth in transaction services (7%) was offset by declines in securities and banking 12%. For whatever reason, it helps shareholders, this performance is likely to be the rule for other large banks like Bank of America (NYSE:BAC) (BofA) as well.
On a slightly more concerning note, operating expenses were up 8%. Most banks, and particularly those with sizable foreclosure issues like Citi, BofA, Wells Fargo (NYSE:WFC) and so on, are seeing higher expenses as it takes personnel and money to process these matters.
At the end of it all, Citi did slightly beat the analyst expectations for earnings, even after adjusting for a sizable gain from liability re-evaluation. Unfortunately, it looks as though around half of earnings came from further reserve releases, and this should continue to decline as the company's credit profile normalizes.
Where's the OUS Growth?
One concerning detail, of the quarter, was the relatively unimpressive growth in Citi's Latin American and Asian operations. A quick look at the stocks of Korean banks like Shinhan (NYSE:SHG) and KB Financial (NYSE:KB) or Latin American operators like Banco Santander Brasil (NYSE:BSBR), Itau Unibanco (NYSE:ITUB) or Creditcorp (NYSE:BAP) would certainly corroborate the idea that this is no longer a red-hot space. Longer term, this is a good place to be, but it looks like Citi can't count on these regions to speed its recovery.
At the same time, Europe could still be a problem. Citi almost certainly has billions of dollars still at risk in Greece, Portugal and Ireland, to say nothing of the knock-on risks in countries like Spain, France and Germany.
There's the problem, then, with trying to value Citi on its book value - there's a good argument to be made that those loans will take a haircut, and with it the company's equity and book value. This does not mean that the company's capital is in serious peril, but it's a reminder that the trouble isn't over.
Where Does the Bank Go?
One of the issues with Citigroup is that the company's strategic direction is still uncertain. For instance, the company has apparently decided to keep the retail partner cards business - probably not a bad decision given that the bank does not desperately need the capital, and it can be a profitable business in the future. But, this restructuring has cost the bank valuable assets like Smith Barney (which it conveyed to Morgan Stanley (NYSE:MS) in a complex deal), and nobody knows how much more shuffling is left before the bank's management has the hand it wants to play.
The Bottom Line
The story on Citi is the same as it has been for a while now. Assuming that there are no major write offs left to come, and that the bank can eventually regain (and hold) a return on equity of 10% or better, the stock is undervalued - probably close to 50% undervalued. The trouble is, that same argument holds for a lot of banks right now, and it is hard to argue for owning Citi when U.S. Bancorp (NYSE:USB) or PNC (NYSE:PNC) offer pretty solid appreciation potential with a lower risk profile. Still, for those who like to play the deep-value turnarounds, Citi, for all of its problems, is not a bad name to consider. (For additional reading, see Analyzing A Bank's Financial Statements.)
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by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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