Banks in the US have encountered an uncertainty factor related to the interest rate hike, in addition to the oil prices slump and the slow growth in the Chinese economy. Amid a tough macro environment, investors remain concerned over the significant sell-off in financial stocks. Bidness Etc takes a detailed look at Citigroup Inc. (NYSE:C) in particular, favoring the stock in light of its strong fundamentals.
Citigroup reported strong earnings in its fourth fiscal quarter (4QFY15) compared to analysts’ expectations. Profit earned in the three-month period ended December 31 was $3.34 billion, resulting in yearly profit to rise to $17.2 billion. The annual profit for 2015 was the strongest since the financial crisis and grew nearly 135% in 2015. Citigroup was able to increase its profits largely due to a decline in legal costs and improvement in revenues. Revenue growth was driven by growth in Citi Holdings’ revenue, which contributed 9% to the company’s total income. Earnings per share (EPS) came in at $1.06 for 4QFY15 and $5.34 for the full fiscal year 2015, representing a 10% YoY growth.
The important fact to consider is that with an increase in revenue, banks typically see an increase in operating expenses. However, in Citigroup’s case, the bank has been efficient in generating cash, thus seeing an improving efficiency ratio.
Citigroup has been able to maintain its net interest margin at a steady level of 2.94 in 2015 and 2014. In comparison to its competitor, Bank of America Corp’s (NYSE:BAC) net interest margin declined from 2.45 in 2014 to 2.34 in 2015. It is worth noting that Citigroup has maintained its interest-generating ability over the span of one year. We believe the bank has potential to improve its earnings from interest-generating transactions once the Federal Reserve decides to get back on the track of rate hikes.
Additionally, Citigroup has proven its ability to improve financial results by other than interest-related businesses. The bank was able to improve its non-interest income by nearly 2% over the period of 12 months ended December 31. Analysts at S&P Capital IQ assert: “The largest banks have significant amounts of their assets in federal fund securities and other extremely low-yielding investments,” so the banks are likely to benefit from the expected rate hike.
Moreover, Citigroup has deployed cost-cutting measure such as layoffs on an annual basis and downsizing its operations from various international markets. In 4QFY15, expenses were down 23% YoY, on back of ongoing efficiency savings and lower repositioning costs. The decline was largely driven by lesser legal expense. Until December 31, the bank has exited nearly 19 markets, making its business simple, small, and more focused on areas where it had been able to generate better return for its shareholders. The bank had also shrunk its size as more regulations were imposed since the financial crisis. All these measures, including efficiency gains in retail banking, efficiency in savings, and improvement in business model contributed toward the overall gains and helped the bank improve its efficiency ratio.
In terms of last quarter’s efficiency ratios, Citigroup stood at 61.22%, significantly lower than Bank of America’s 70.20%. Citigroup’s efficiency ratio has considerably improved when compared to 2014 and is now well positioned to generate free cash flow. This presents a clear picture that Citigroup has been able to recover its position as it was heavily damaged by the financial crisis. With Citicorp’s efficiency ratio of 57.1%, the metric “was just over our [Citigroup management] target and it was more than 300 basis points lower than in 2012,” said Michael Corbat, CEO of the bank. As for the full year 2015, efficiency ratio for the bank including Citi Holding was 57.3%.
Considering the stock valuation, Citigroup has been trading at a discount when compared to its tangible book value. According to Bloomberg, price-to-tangible book value ratios for Large Banks Competitive Peers in the US have a median of 1.26. The ratio for Citigroup currently stands at 0.70. This reflects that Citigroup stock is trading around a 30% discount to its tangible book value. An analyst at CLSA highlighted that now banks have strong balance sheets whereas, the stock price “resembles recession trough.” We infer that it is investors’ perception that the bank’s assets are overvalued, which has weighed down its stock. However, given the margin of safety in Citigroup stock’s discount, we believe that the stock is trading cheap, posing an attractive buying opportunity considering its fundamentals and strong earnings potential.
In our view, it has been almost a decade since Citigroup reported such strong earnings and revenue. This indicates the bank’s strong growth potential in the long term. At this point it time, ahead of the 2016 stress test, we would also like to reiterate the fact that Citigroup witnessed the cleanest pass of the stress test and CCAR last year. With efficient controls and strong capital standing, the bank was also able to satisfy the Federal Reserve’s requirements.