There’s value in Citigroup shares
Even though citigroup’s share prices tripled since its chairman axed former CEO Vikram Pandit in a boardroom palace coup in November 2012, America’s quintessential global money centre bank still trades at book value. However, several trends in international banking are bullish for Citigroup shares. One, the Federal Reserve’s hawkishness at Chairman Powell’s first FOMC means a steeper US Treasury yield curve and thus higher interest rate margins. Two, Citi plans to increase its payouts to investors given that its global franchise generates excess capital. Three, Trump’s tax cuts have boosted the bank’s return on tangible equity to 10.5 per cent in 2018. This could rise to 12 per cent next year. Four, a synchronised global economic expansion benefits Citi given its vast exposure in Asian, Latin American and Mena consumer/corporate banking and capital markets.
Five, Citi’s cost/income ratio is at 57 per cent, in a downtrend, albeit glacial. Six, Citi management projects revenue guidance of 3 per cent. Seven, with a lower effective tax rate of 24 per cent, Citigroup has a unique opportunity to use big data analytics, machine learnings, new applications and distribution platforms to leverage its technology prowess across hundreds of businesses worldwide. This is particularly true for emerging markets like Mexico, where Citi runs a full-service consumer bank (Banamex). Eight, the rollback in Dodd Frank and restrictions on derivatives is positive for Citigroup, the financial conglomerate for which President Clinton originally scrapped the Glass Steagall restrictions that separated commercial from investment banking. Nine, Citigroup can well deliver $7.6 in EPS next year. So, Citi trades at 9.2 times forward earnings, among the lowest multiples among its US money centre bank peers.
True, investors place a higher risk premium on Citi due to its traumatic near death and de facto nationalisation by Uncle Sam in 2008. Those were the days when Citi’s advertising tagline was “the Citi never sleeps” — and neither did its depositors, shareholders and regulators. Yet the New Citi is a less leveraged, better capitalised, more profit-focused, better riskmanaged version of the bank led to the precipice of fi- nancial Armageddon by John Reed in 1991 and Chuck Prince in 2008. This is not to suggest that trading setbacks, frauds and failed Fed stress tests have not happened on CEO Mike Corbat’s watch.
Citi’s emerging market exposure can also be a source of risk due to the threat of cross-asset contagion. I remember the 1994 Mexican peso devaluation, the 1998 Asian flu, the 1998 Russia rouble default, the 2001 sovereign bankruptcy of Argentina and the 2008 global financial crisis all too well. Citi’s return on equity is also 500 basis points lower than JPMorgan or even several US regional banks, so it makes total sense for the bank to trade at a valuable discount. My only argument is that the valuation discount is excessive at a time when returns on tangible equity, shareholder buybacks, the efficiency ratio, the Basel Tier One capital ratio and real GDP growth in the global economy are all set to rise. Oscar Wilde reminded us that price does not equate to value on human life — and the stock market.
The US economy exhibits eerie echoes of 1994, a year when the bond market lost more money than in any financial crisis since the Wall Street Crash of 1929. In 1994, economic growth accelerated and inflation began to rise when real rates were still zero. The result? A series of unanticipated Fed rate hikes and an epic bloodbath in the bond market. In 2018, the US tax cuts and faster export growth could well force the Powell Fed to tighten more aggressively than the capital markets consensus, exactly as happened to the Greenspan Fed in 1994. The financial markets have been lulled into complacency by Janet Yellen’s dovish dotplots and genteel gradualism on monetary policy. However, the world has changed under President Trump. Sometime this autumn, Jerome Powell will have to ditch her dotplot and hike interest rates faster and higher than Wall Street projects. This is the point when the world will learn the meaning of a “shock and awe” Fed the hard way.
Europe’s valuation is compelling with the Stoxx 600 index at 365 as I write MSCI Europe now trades at a forward valuation of 13.6 and a forward dividend yield of 3.9 per cent, the most attractive valuation metrics since late-2016. With Brent at $70 and the euro at 1.23, there is no doubt that the earnings of European cyclicals are vulnerable to a slowdown in the growth momentum.