Citigroup’s Strong Q3 Performance Reinforces $64 Price Estimate

Citigroup (NYSE:C) has come a long way over the past several years, and the banking giant’s third quarter results highlight the success of its efforts to improve profitability in the stricter regulatory environment. ^[1] Citigroup was the first major banking group to establish a non-core operations division (Citi Holdings) to work through its legacy issues in an efficient manner, and these operations turned profitable late last year. Citigroup then shifted focus to streamlining its cornerstone consumer banking business, and progress on this front has helped the bank comfortably beat earnings expectations in the last three quarters despite the pressure on revenues. Finally, Citigroup has one of the highest common equity tier 1 (CET1) capital ratio figure among all U.S. banks – something that will allow it to substantially hike the amount of cash it returns to shareholders in the near future.

Taken together with the fact that Citigroup has resolved substantially all of its legal backlog, it is surprising that the bank’s shares continue to trade at less than 80% of their book value. In fact, the current market price is roughly 10% below the tangible book value per share as well – indicating that investors are relatively skeptical about the quality of assets on Citigroup’s balance sheet.

We believe that these fears are largely unfounded, and maintain our $64 price estimate for Citigroup’s stock, especially since the improvement in operating margins over recent quarters appears sustainable. Our price target is roughly 20% ahead of the current market price.

See our full analysis for Citigroup

Trading Revenues Depressed In Q3, Expect Steady Growth 

Citigroup generated revenues of $3.6 billion through its trading operations (fixed-income and equities taken together, adjusted for CVA/DVA) for the third quarter of the year – roughly 4% lower than the figure for the previous quarter and 7% below the figure for the year-ago period. This trend of a year-on-year reduction in total trading revenues was seen across the industry, with rivals Goldman Sachs (NYSE:GS) and JPMorgan (NYSE:JPM) witnessing much sharper declines. The overall performance was largely in line with estimates provided by Citigroup’s top management, who expected a 5% reduction in these revenues since last year. ^[2]

Revenues for the FICC (fixed income, currencies and commodities) trading desk fell to just under $2.6 billion from around $3 billion in each of the two comparative quarters – a reduction of 16%. On the other hand, equities trading revenues of nearly $1 billion for Q3 2015 were roughly 31% ahead of the figure for Q3 2014 and a good 53% higher than that for Q2 2015. It must be mentioned here that Citigroup’s equities trading desk fared worse than competitors in Q2 2015, and the jump in revenues this time around is commendable. With Citigroup recently revealing plans to expand its presence in the global equities trading industry, the corresponding changes would have been an important factor behind this marked improvement. ^[3] The bank’s strong position in the FICC trading industry, combined with the potential value that renewed focus on equities trading is likely to unlock, will drive profits for Citigroup in the future.

Geographically Diverse Consumer Banking Division Anchors Results

Citigroup’s biggest strength is its extensive global presence. That, combined with the fact that Citigroup is a leader in a range of financial services, allows the bank to benefit from diversified revenue streams that are not subject to the restrictions faced by its peers that are largely focused on U.S. markets. Citigroup’s strong retail banking presence across the globe and in emerging markets gives it access to cheap funds in the form of low interest rate deposits from the regions in which it operates, allowing it to achieve better net interest margins. As the bank caters to the demand for loans globally, its interest income is not overly dependent on the interest rate environment prevalent in any single country. The table below summarizes Citigroup’s reported net interest margin (NIM) figures for each of the last fifteen quarters:

The bank’s interest margin has remained largely around the 2.9% mark over the last three years, in sharp contrast to peers like Wells Fargo that have seen a reduction in this figure by more than 100 basis points (1% point) over the same period. This has helped Citigroup’s net interest income to remain around $12 billion over the last five years, with foreign exchange movement having a bigger impact on these revenues compared to changes in interest rates between quarter. That said, more than 55% of Citigroup’s total interest-earnings assets are in the U.S., so the bank will definitely see an improvement in total revenues once the Fed hikes benchmark interest rates.

While Citigroup should be able to leverage the extent of its geographical diversification to grow its top line in the future, its efforts to cut down on operating costs will boost overall profitability. Although revenues for Citigroup’s consumer banking division were noticeably lower in Q3 2015, the bank achieved a sharper reduction in non-interest expenses – allowing efficiency ratio (defined by the bank as the ratio of total operating expenses to total revenues) for the division to remain largely unchanged. Total non-interest expenses for the division fell below $4.5 billion for the first time in five years for Q3 2015. The impact of reducing retail banking operating expenses on Citigroup’s share value can be understood by making changes to the chart below.

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1. Q3 2015 Earnings, Citigroup Press Releases, Oct 15 2015 [↩]
2. Citigroup Sees Trading Revenue Falling 5% in Third Quarter, The Wall Street Journal, Sep 16 2015 [↩]
3. Citi aims to boost equities franchise amid industry shakeout, Reuters, Aug 31 2015 [↩]