Stock Analysis: Citigroup (C)

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

Last week, Citigroup posted their second quarter results which came in pleasantly above expectations.  With earnings coming in at $1.51 and revenues modestly beating at $19.2B.  The biggest factor to the earnings beat was the dramatic decrease in legal expenses, with an ongoing theme that these should continue to improve in the quarters ahead as well.  Diminishing legal concerns help us find clarity in what the company is capable of doing.  Gains made from their trading business was respectable, costs continue to be pulled down under control and the anticipation of looming rate hikes mean banks will be able to make more money in the future.  All of these things create a scenario where banks are entering into a sweet spot for potential profits.

While things are looking better, things still are not perfect.  With a weak global economy, we won't be seeing rapid growth.  Additionally, extracurricular events like we saw with Greece can hit the stocks negatively.  This is partially due to the fact that Citigroup is a global banking entity, and in part due to the fact of those types of events driving down the same interest rates that are expected to go higher.  The next thing is that though legal fees are heading in the right direction, we're not guaranteed that the banks are fully out of the woods with the Justice department yet, so any legal news could send stock reeling again.

As for the stock itself, I need to shift away from my conservative tone, as the market sentiment, as well as the company's ability to deliver, has changed.  They have already reached my target tangible book value of $59 halfway through the year.  Last October I went through the process of calculating where I thought tangible book value was heading and I stayed conservative.  Based on performance and where I see things heading, I'm going to recalculate and get more aggressive.  In the last 3 quarters, the tangible book value has grown by about 2.2%.  With things improving, I'm going to guess that the book value can grow by another 2.5% in the second half of the year.  For the sake of rounding to nice numbers, I'll say that gives a TBV of $60.50 when the company announces in January.  Next is the multiple to the book value that I feel is appropriate and fair.  This is where things really explode.  Up until today, Citigroup has been trading below its TBV for the last number of years.  I was playing conservatively, stating the stock should be priced for one times that value.  Meanwhile many banks in its industry have been sitting at higher multiples all the way up to the the whopping 2 times book value that Wells Fargo gets.  Citigroup's peers are getting an average 1.6 times multiple and the industry is sitting at 1.4 times book.  This means Citi is prices way below its brethren and has the most room to run, providing it can keep its house in order.  Because it's been inconsistent and is unloved, I'm going to go a little more conservative on the multiple for now.  Let's say the stock should be priced at 1.25 times book value.  That puts my price target for the stock at $75.63 (let's just say $75.50 for ease).  Yep, I just raised my price target from $59 to $75.50!  This might sound explosive, and to a degree you're right - a 25% move in 6 months could be seen that way.  However, this valuation is still below the industry average both for today and historically speaking.  Additionally, given estimates for the next two quarters, Citi could earn over $5.60 this year.  at $75.50 that's a P/E multiple just over 15, compared to an S&P historical average of 16-17.  Oh, and did I mention that those earnings are almost a 50% increase over the year prior with interest rate increases only raising the potential for continual earnings growth in the future.  This is what drives prices, folks, and Citigroup is flat out cheap.

It's a little early to tell, but I think we have a new floor forming around the $59 mark.  Even if it were to break, the down side is still likely to be in the mid fifties.  This creates a favorable risk-reward profile for the stock.  While I have no intentions on buying more shares as my position is full, I have high conviction in this stock and believe it can be ranked a one up to $65 over the next few months.  I will set my target price at $75.50 based on a TBV of $60.50 and fair price being 1.25 times that value.  However, I think we won't likely see that price until 2016.