- Citigroup valuation metrics are cheaper than industry average and rising. Also Citigroup's shrinking balance sheet has its debt to equity ratio at very low levels.
- International exposure will give Citigroup an advantage over its US peers. Growth will be tepid at best in the west over the next decade.
- Non interest expenses are expected fall which will boost the company's efficiency ratio.
The Federal Reserve ended its multi-year zero rate era on 17th December by raising interest rates by 0.25 percentage points. Citigroup (NYSE:C) has had its fair share of problems since the great recession and has under-performed the financial sector in general since bank stocks started to collapse around the start of 2007. (see chart)
Furthermore Citigroup (NYSE:C) stock price has been pretty much static since the stock split back in 2011 whereas you have the likes of Wells Fargo (NYSE:WFC) which has seen its stock price almost doubling in the same time period. This doesn't necessarily mean the divergence will continue (compared to the Financial Select Sector SPDR ETF (NYSEMKT:XLF) ) but rising interest rates alone is not going to be the catalyst needed to drive Citigroup stock price forward.
Investors somewhat falsely believe that a rising Fed fund rate automatically improves Bank's valuations but this isn't necessarily true. I previously discussed here the importance of long term interest rates to banks but not only that is critical but also the speed and magnitude of the impending increases in interest rates. In the event that the US economy is able to withstand a tightening policy (which we still don't know), then and only then would I recommending investors to start scaling into Citigroup.
Firstly lets take a look at the Citigroup valuation to see if there is inherent value compared to its peers. The shrinking of Citigroup balance sheet since its bail-out has meant that its debt to equity ratio has shrunk to 1.04. This is the lowest it has been since the height of the great recession when it was 5.07. Also Citigroup's other valuation ratios are well below industry averages which illustrates straight away how much the market is discounting Citigroup's growth potential.
Furthermore Citigroup's price to sales, price to book and price to cash flow ratios are slowly rising which is encouraging as it indicates that the stock may have bottomed out. Why the sudden rising trend? Well if interest rates continue to rise at healthy clip, earnings have to follow. Currently Citigroup has a price to earnings ratio of 12.1 and a forward price to earnings ratio of 9.3 which are well below numbers in this sector. If the main valuation metric continue their ascent, Citigroup's p/e ratio will have to follow which will boost the stock price.
What will move the needle for Citigroup going forward? Personally I believe Citigroup's international exposure is what really differentiates Citigroup from its competitors in that Citigroup is somewhat shielded against potential stagflation or deflation in the US and Europe. Wells Fargo for example is 95%+ US based which limits its diversification and increases risk but Citigroup stands to benefit through Citigroup's substantial international presence from economic growth in Latin America and Asia.
Many forget that Citigroup stock price more than doubled between 2002 and 2007 primarily due to the US housing boom and Citigroup tripled its dividend to $5.40 a share. In China alone, Citigroup has 52 consumer bank outlets and 13 corporate bank branches and continues to grow its presence. As the world becomes smaller through technology and travel, Citigroup definitely stands to benefit by providing the same service across multiple borders.
Therefore I wouldn't read too much into the 6% year on year drop in Asian revenue reported by Citigroup last quarter. China is going through its own troubles at present but long term growth is the general consensus for this country going forward.
Citigroup stock rallied 2.65% after the rate hike announcement. Citigroup immediately hiked its prime rates to 3.5% which will mean higher rates on credit cards and small business loans to name but a few. Richard Ramsden of Goldman Sachs (NYSE:GS) is bullish on Citigroup owing to the net income potential gain potential, the strength of its balance sheet and the predicted decline in Citigroup's non-interest expenses that has carried over since the last financial crisis.
Furthermore the combination of higher net income from rising rates combined with declining expenses should mean that Citigroup can achieve an efficiency ratio of 53 in the near term. Last quarter's earnings definitely demonstrated that metrics are going in the right direction.
To sum up, I believe Citigroup has the huge benefit of being highly diversified across multiple borders which means it can participate in economic expansion in these areas. Whereas the US may "seemingly" appear to be top dog at the moment, we still do not have any idea about what shape its economy will be in 2 years time.
At the end of the day, the indebted countries are in the west whereas the creditors are in the east. Citibank already has a large portion of its revenues coming in from Latin America and Asia. Emerging economies will probably remain weak in the near term but fundamentals are favorable which is why Citigroup stock should do well over the long term.