Value investing is about obtaining more value than the amount of money that you are putting in. There are metrics to track whether intrinsic value is growing or declining. Usually, stock prices track intrinsic value, although the time it takes for the prices to converge can vary greatly. It would be tough for me to name a more frustrating investment than the common stock of Citigroup (NYSE:C). The stock has been chronically cheap, but typically it has rallied close to tangible book value after significant dips, offering opportunities to lock-in profits, until lately. Citigroup’s management has been given a long leash to transform the company, but investors need to see more urgency in delivering capital returns, expense efficiency, and growth in wealth management. Citigroup’s stock should double over the next three years, but it will all depend on execution of these priorities.
When Jane Fraser became CEO of Citigroup, she had big plans. The goal was to divest noncore international consumer businesses, which struggled to achieve scale. The bank was to aggressively invest in modernization, both to meet regulatory demands and to improve efficiency. The bank was going to lean into its lucrative TTS business and attempt to increase its presence in Wealth Management. While I think there is strong merit to the plan, I’d have to give management a C- in execution. Yes, they have exited and are exiting many markets, so progress is good there. TTS is performing very well, bolstered by higher rates, which is a nice tailwind that I can’t give management too much credit for, although they are winning market share too. Expenses have been very high as forecasted, and most investors understand that this is necessary, but communication on exactly how the curve will bend has been lackluster. Citigroup has seen its capital requirements grow, which has impeded its ability to buy back stock, until finally buying $1B in Q2. Nothing the bank could do is more accretive than stock buybacks at current prices, so perhaps management should reduce the 100bps management buffer once new capital requirements become clear, so they can lean in and finally do something for shareholders. I think management made the right decision in not selling Banamex when it became politicized. It is a great business, so an IPO is a good option, and the business is accretive in the interim. It’s time for management to show a real sense of urgency in improving returns as it has been absolutely brutal for investors.
On July 14th, Citigroup reported 2nd quarter net income of $2.9B, and EPS of $1.33. Revenues excluding divestitures were pretty much flat YoY. Citigroup’s ROTCE of 6.4% on the $19.4B of revenues is hopefully a trough quarter, given the weak trading and investment banking conditions. After-tax divestiture related impacts were roughly $92MM, reducing EPS by $.01. TTS continues to star in a higher interest rate world, generating 15% revenue growth. U.S. dollar clearing volumes were up by 6% and cross-border flows were up 11%. Security services revenues also rose by 15% as the company continues to grow its lucrative assets under custody and administration, where the company has gained 100 basis points in market share YoY. These positives were offset by Markets revenue being down 13% from a very strong prior year performance. Trading can be pretty cyclical and concerns over the debt ceiling and low volatility led to weak results across the industry in Q2. Investment banking continues to be a major drag with revenues down 24% YoY. Citigroup’s Cards businesses had double-digit revenue growth, as customers relied on them more and are not paying off debt as rapidly as in the last few years. Wealth revenues were down 5%, as deposit costs continued to perk up, particularly in the Private Bank, along with lower investment revenues. Net interest income increased by around $550MM YoY, driven by higher rates, offset a bit by higher deposit costs. Average loans were flat as growth in PBWM was offset by the runoff markets and a decline in ICG. Average deposits were down 2%, largely in TTS where the company saw some non-operational outflow, but they continue to see growth in operating accounts. NIM increased by 7 basis points.
2023 has been a year defined by enhanced investments in the business, which are a short-term drag on profits, but are essential to meeting regulatory requirements and modernizing the business. Expenses of $13.6B, were up 9% YoY, while cost of credit was approximately $1.8B, driven by normalization in cards and ACL builds. Year-to-date severance has been roughly $450MM, including $200MM in Q2. Technology spending was $3B in the quarter, up 13%. The company plans on bending its cost curve by the end of 2024 through three major efforts. Firstly, the company continues to invest in its transformation and other risk and control initiatives, essential to modernizing and automating its infrastructure. Secondly, the company is focused on simplifying its footprint by closing the sales of the remaining two Asia consumer franchises by year-end and restarting the exit process in Poland. Banamex will likely be separated fully next year in preparation for the IPO. Lastly, the company plans to adopt a leaner organizational model, reducing redundancies where they exist etc.
While everybody has been waiting for the recession to hit over the last year or so, credit has continued to outperform. At the end of Q2, Citigroup had over $20B in total reserves, with a reserve to funded loans ratio of approximately 2.7%. The reserve for U.S. Cards is 7.9%. In PBWM, 44% of lending exposures are in US Cards, and 80% of that is to customers with FICOs of 680 or higher. The remaining 56% of PBWM lending exposure is largely in wealth, predominantly in mortgages and margin lending. In the ICG portfolio, 85% of total exposure is investment grade, including 90% internationally to investment grade or multinational clients and their subsidiaries. Citigroup’s ROTCE through the first half of the year was 8.7%.
Citigroup suffered a big disappointment in the latest CCAR process, where it learned it will face an increase in its stress capital buffer, which came as a major surprise. While the process is a black box affair, the Fed has substantially worse expectations of non-interest revenue, which created the shortfall. We’ll learn more as Basel III Endgame is released in the next month or so, and the company is engaging with the Fed to try to figure out the disconnect between their models. This capital requirement increase is a blackeye on management, but there is only so much they can do with limited transparency. Exiting 14 international consumer markets, reducing RWAs where economically attractive to do so, and continued utilization of the DTA etc., ultimately should secured a lower stress buffer in a year or two. Thankfully, the company finally took advantage of the absurd stock price by buying back $1B worth of shares. The bank ended the quarter with a CET1 ratio of 13.3%, which is 100 basis points above the upcoming requirement after returning $2B in capital through the buyback and dividends. Tangible book value per share continued to grow to $85.34, up 6% YoY. It’s been amazing and painful as a longtime investor in Citigroup to see the best proxy for intrinsic value continue increasing, only to have the valuation compress further and further.
Citigroup is maintaining its full-year revenue guidance of $78 to $79B, excluding 2023 divestiture impacts. Net interest income is being guided up to $46B from $45B, excluding markets, offset by lower noninterest revenue, due to weaker investment banking and wealth management. The company is also maintaining its guidance of roughly $54B of expenses, excluding 2023 divestiture-related impacts and the FDIC special assessments. Management believes that net credit losses in cards will continue to normalize as the year progresses, with both portfolios reaching normalized levels by year-end.
At a recent price of $45.75, Citigroup trades at a paltry 53.6% of tangible book value. Earnings have averaged $17B over the last 5 years, and the market capitalization is under $90B. The dividend is just under 4.5% so investors are being paid to wait. With a CET1 ratio of 13.3%, Citigroup is in good shape and once it gets a little more clarity on the final capital requirements, I’d expect the company to lean in on buybacks. Even at $5B a year, this would be incredibly accretive at current prices, given the massive valuation disconnect. Most of the divestitures will be done by year-end and the expense curve will start improving towards the back half of 2024, which should be another major catalyst for the stock. Citigroup’s deposit base consisting of mostly core operating deposits has held up far better than most peers, so the company is in great shape in that regard. I absolutely understand investors losing patience with this stock, but the reward/risk is too good at current prices. Intrinsic value metrics have continued to improve but Mr. Market hasn’t noticed and has simply ascribed a lower valuation to the business. I think we should see major improvement over the next 18-24 months as Citigroup begins its assent to $80 per share.
Read the full article here
