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Citigroup (NYSE:C) (NEOE:CITI:CA) is currently trading at ~0.65x tangible value (“TBV”) which is certainly a distressed valuation, although it did recover some in the last year or so. Still, the stock is significantly underpriced in my view and I think it is important to understand why the market is pricing the stock at such a large discount to tangible boo
There are several key aspects that Mr. Market is concerned with and skeptical about, this includes the following:
Citi chequered recent history and essentially became known as the “banana peel” bank. If there was a banana peel somewhere out there in the global economy, Citi somehow almost always managed to slip on it. Mr. Market remains unconvinced about Jane’s strategic restructure. Whilst acknowledging good progress around cost-cutting and simplification of the firm, serious questions are being raised on what is being seen as an ambitious revenue growth trajectory. The uncertain macro environment and specifically the combination of lower rates (and lower NIM) as well as the risk of heightened credit losses, especially in its Cards business. Mr. Market also doubts whether Citi’s perennial control framework problems can be solved in the near term. The recent fine by regulators for failing to resolve the Consent Orders in good time is clearly not helping in restoring confidence in management’s ability to execute, or perhaps Citi is just too big or complex to manage.
So putting all of the above together, Mr. Market feels justified trading the stock where it is. Whilst I do understand the market’s skepticism when it comes to Citi, my strong view is that underneath the hood, great progress has been made that is likely to facilitate compounding shareholders’ returns in the next few years.
I have been following Jane’s strategic restructuring closely over recent years and am reasonably confident that Citi is on the right track. Mr. Market has just not recognized this as yet. I also believe that 2025 is going to be the pivotal year when several catalysts will come together and the stock price could go up very quickly.
The Power of Share Buybacks
Citi’s management team is confident in delivering its target of 11% to 12% RoTCE by 2026 (and continues to improve from there). Assuming a cost of equity of 10%, this translates to a valuation of 1.1x to 1.2x of TBV or $110 to $120 share price based on a projected TBV of $100.
So the opportunity to buy back a large percentage of the float at the current discounted valuation is exceptionally accretive and with a large margin of safety. Unfortunately, in recent years, Citi’s share buybacks have been disappointingly modest. There are several reasons for this, which include potential capital increase due to Basel 3 and tougher stress tests (otherwise known as CCAR) that forced Citi to maintain extra buffers of capital.
However, these capital headwinds are dissipating quickly. Basel 3 end-game rules are being re-proposed with a much lower increase in capital than initially feared and Citi has begun to successfully reduce the impact of CCAR in part due to the execution of its new strategy which is designed to decrease Citi’s overall capital requirements. Finally, in 2025, with the expectation of the IPO of Citi’s Mexico operations, additional significant capital is expected to be released as well. So all in all, the expectation now is that Citi should be able to meaningfully ramp up its return of capital allocations in upcoming quarters, and at 65 cents in the dollar, this is a very important use of capital and a key catalyst for the stock.
Not A Lipstick On A Pig
The current strategic restructure is about completely rewiring and modernizing the bank, but importantly in a sustainable manner that should set up a trajectory of increasing returns and catching up to its U.S. peers in terms of returns and valuation.
I will be the first one to admit that previous restructures were driven by meeting short-term financial targets in a particular year and cutting many corners along the way.
The current restructure feels different. Jane has made very tough decisions around the parameters of the firm as well as people. In a few years, this will likely be seen as a pivotal moment in Citi’s post-GFC history.
The management team is clearly focused on this, as commented by Citi’s CFO at the recent Barclays Global Financial Services Conference:
So, what I want investors to take away. Execution against the transformation. Driving improved business performance, right? We are keenly focused on how do we improve our returns and not only deliver on the 11% to 12% in the medium term, but position these businesses for returns that are higher beyond that medium-term period. We’re making those investments. And both of them require investment, we’re doing it. And we’re doing the transformation in this operational overhaul in a way that allows for us to sustain a competitive advantage over time.
We’re investing in these businesses by bringing in top talent, by changing the way we think about client coverage, by investing in the products and services that we have, and by taking advantage of our unique competitive position in each and every one of them.
And so — and the final point I’d make is that — is the point I made earlier, which is in doing so, we’re keenly focused on how we can return capital to our shareholders over time. Because we understand, again, where we’re trading, and we understand that there’s a real opportunity to improve that performance, both through improving the return on and return of capital.
Final Thoughts
After rapid climb from $40 to almost $70, Citi share price retraced back to a share price ~$57. This partly driven by the macro fears and increased possibility of lower rates, which by all accounts is a reasonable reaction function from Mr. Market.
However, what many investors are missing is the very real and fundamental changes happening at Citi under the hood and importantly, the likely prospects of increased share buybacks at a great discount to book and inherent value. Absent a severe recession, I see the current share price action as an opportunity, and thus will trade accordingly. I remain very bullish.
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