The financial holding company Citigroup (C)--hard hit from the subprime mortgage crisis and recession--has struggled to recover shareholder value. Since the reverse stock split in early May, the company has lost more than a third of its value. The stock is down 38.7% for the year while the S&P is down only 3.3%.
Currently, analysts rate the company somewhere between a "hold" and a "buy". The stock nevertheless has attracted a lot of attention from notable value investors. Bill Ackman has a large stake in the company, along with Paulson & Co. at 1.15%. Core Value investors own approximately 13.5% of the $84.6B market cap company. While there is a lot of upside to Citigroup for its leading diversification in international banking, there is also lot of risk inherent in the firm.
In light of the financial meltdown, irrational markets may very well have exaggerated the risk in Citigroup. The company had a $10.6B profit in 2010, which was unanticipated. Furthermore, taxpayers earned $12B in their investment when many thought that it would end up just as a "rescue attempt". The risk-averse sentiment of the current market allows for value investors to lock in a profit when the market corrects its emotional anomaly. To speed up that correction, the financial holding company is currently unwinding its riskiest segment, Citi Holdings. Citi Holdings provides Brokerage and Asset Management, in addition to Local Consumer Lending and special asset pools.. The new Citigroup will entail a strengthened Citicorp, which offers Regional Consumer Banking and Institutional Clients Group. Below is a breakdown of the Citicorp's income by segment for 2010:
*note that "EMEA" refers to Central and Eastern Europe, Middle East, and Africa.
What attracts me to Citigroup is that it is becoming increasingly driven by growth in Asia. Asia represents most of the profits in Citicorp at $4.6B, followed by North America at 3.7B, and then EMEA at $3.2B. For investors looking for exposure to emerging economies, Citigroup may very well be the best vehicle. The global banking colossus does business in 160 countries.
The middle class in Asia is also growing fast and will likely represent higher consumer expenditures than the United States within the coming decade. Citigroup is well positioned to exploit this trend. As for business in the United States, increased interbank lending and lower leverage are key factors that will increase my confidence in the company.
With nearly $2T in assets as of late June 2011, no market analysis on Citigroup would be complete without mentioning how inorganic consolidation drove most of the company's growth throughout the last decade. The corporation acquired credit card assets, loan portfolios, Salomon Smith Barney, Washington Mutual, and many more. Despite the acquisitions of brand-name firms, Citigroup faces intense competition. I am hesitant about this strategy insofar as I think increasing scale should be second to improving credit quality in this industry. The ongoing restructuring in operations can help to produce synergies, but creating that value remains very much a work in progress.
With a PE ratio of 8.8 and a forward PE ratio of 5.9, a multiple of 2.1x cash flow, the firm appears undervalued. The risky nature of the stock will drive greater returns as the company continues to grow in emerging markets. Consensus estimates for EPS are that it will grow by 15.4% to $4.04 and then by 24.5% and 14.9% for the following years. Using a DCF model, I find that the company is trading at approximately 22% below its intrinsic value. My estimate comes through factioring in a WACC of 10.7%.
In conclusion, I believe that the market has overreacted to the financial meltdown in a way that will result in higher risk-adjusted returns for Citigroup in the near future. I further find myself in agreement with the goals set forward by the company's current management to increase investor confidence. A stabilizing TED spread may go a long way to reduce investor's fears, but it will not eliminate them. With a global reach and strong holdings, Citigroup provides tremendous upside, albeit with high risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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