Citigroup Is Worth $61 Despite Its Dismal Operating Performance In Q4

Late last week, Citigroup (NYSE:C) reported revenues and earnings for the fourth quarter that were ahead of investor expectations – a notable achievement given the overall weak market conditions prevalent over the period. ^[1] But investors were quick to look past these two figures, and realized that the seemingly strong performance was primarily due to one-time gains for the non-core Citi Holdings division. More importantly, the bank’s core consumer banking business reported a 10% reduction in total revenues and a sharp 18% decline in pre-tax profits year-on-year. Also, the bank reported a larger-than-expected increase in its loan provisions for the quarter – the result of deteriorating quality of loans handed out to energy companies. The negative implication of these factors on the ability of Citigroup’s business model to generate profits in the near future triggered a sell-off that resulted in the bank’s shares tanking 6.5% over trading on Friday (January 15) after the results were announced.

We believe that the sell-off was not warranted. While revenues for the consumer banking business have shrunk quite visibly, there are two key identifiable factors behind this: a reduction in the sale of Citigroup’s investment products and unfavorable exchange rate movements. Weak global market conditions were largely responsible for soft investment product sales, and we expect this to be a short-term trend that should correct itself in early 2016. As for Citigroup’s exposure to energy companies, the bank had $61 billion in loans to energy companies in its overall portfolio at the end of Q3 2015, of which roughly $13 billion were in the non-investment grade category. Even if we assume 20% of these low quality loans have to be charged off, that still represents less than $3 billion in total value lost for Citigroup – far below the $9 billion that investors wiped out from the bank’s market cap last Friday.

Citigroup remains one of the best capitalized U.S. banking giants, with a common equity tier 1 (CET1) capital ratio of 12%, and its continuing efforts to streamline operations and shrink its non-core divisions will improve long-term profitability. Taken together with the fact that the bank is currently trading at just 60% of its book value and roughly 70% of its tangible book value, the shares appear extremely undervalued. We maintain a $61 price estimate for Citigroup’s stock, which is almost 45% ahead of the current market price.

See our full analysis for Citigroup

Trading Operations Reported Mixed Performance

Citigroup generated revenues of $2.8 billion through its trading operations (fixed-income and equities taken together, adjusted for CVA/DVA) for the fourth quarter of the year – roughly 21% lower than the figure for the previous quarter, but 12% ahead of a year ago. This was largely expected, as a notable reduction in debt trading activity and increased equity market volatility weighed on revenues compared to the previous quarter.

Revenues for the FICC (fixed income, currencies and commodities) trading desk increased 7% from $2.1 billion in Q4 2014 to $2.2 billion in Q4 2015, although the figure declined for the second consecutive quarter. Citigroup’s smaller equity trading desk did well to rope in $606 million in revenues for Q4 2015 – up from $470 million a year ago. Since last August, Citigroup has been working on plans to expand its presence in the global equities trading industry, and the corresponding changes should help revenue growth in the near future. ^[2]

Consumer Banking Division Suffers On Multiple Fronts

Citigroup’s biggest strength is its extensive global presence. That allows the bank to benefit from diversified revenue streams that are not subject to the restrictions faced by its peers who 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 demand for loans globally, its interest income is not overly dependent on the interest rate environment prevalent in any single country – something that has helped it maintain net interest margins around the 2.9% mark over the last few years. This is 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.

While interest-based revenues for Citigroup’s consumer banking division remained strong in Q4 2015, its non-interest revenue figure fell to $1.43 billion – a 17% reduction sequentially and a sharp 27% reduction year-on-year. The negative impact of a strengthening U.S. dollar was responsible for nearly half of this decline, as Citigroup’s consumer banking operations in Latin America fell 17% compared to last year despite reporting revenues that were unchanged on a constant-dollar basis. The lower non-interest revenues are primarily due to a fall in the sale of investment products from $23.8 billion in Q4 2014 to $18.6 billion in Q4 2015. A bulk of this reduction came from the combined Asia-Pacific and EMEA regions, where investment sales fell to $6 billion from a peak level of $13 billion just two quarters ago.

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1. Citigroup Reports Fourth Quarter 2015 Earnings per Share of $1.02; $1.06 Excluding CVA/DVA, Citigroup Press Releases, Jan 15 2016 [↩]
2. Citi aims to boost equities franchise amid industry shakeout, Reuters, Aug 31 2015 [↩]