by Dan Burrows | September 23, 2013 12:59 pm
Analysts expect Citigroup (C) to post a solid profit increase on whopping top-line growth when it reports earnings next month — but they could be in for a nasty surprise.
One of Citigroup’s strengths is its fixed income, currencies and commodities business (FICC), but a dearth of action in interest-rate products and foreign exchange is set to weigh on overall results.
That sluggishness means Citigroup could report a “significant” drop in trading revenue — one sets the bank up to miss Wall Street’s forecasts or worse, according to a report in FT.com
The Street is (or was) forecasting a robust quarter for the nation’s third-largest bank by assets. Earnings per share are expected to increase 7% to $1.13 from $1.06 a year ago. Revenue is forecast to jump 37% to $192 billion from $14 billion recorded in last year’s third quarter.
Well, at least for now. If media reports are right, analysts will be lowering their profit and sales estimates soon. The stock could even catch a downgrade or two.
Should you buy Citigroup’s stock despite the potential for an income and revenue shortfall in the most recent quarter? To help decide, let’s take a look at some of the pros and cons:
A Quarter, Not a Trend: Even if Citigroup posts a disappointing quarter because of weakness in FICC trading, it’s hardly the end of the world. Every broker or broker-dealer in interest-rate products and currencies was hit by weakness in those markets during the quarter. Uncertainty over the Federal Reserve’s taper plans probably had a bunch of traders sitting on their hands. Volume will bounce back.
Global Footprint: Citigroup is by far the most diversified U.S. bank, with operations in more than 160 countries. Despite global weakness, that sprawling footprint actually boosted profitability in the second quarter, as credit quality improved throughout the world. When global sluggishness finally turns into acceleration, Citi is uniquely positioned to profit.
Valuation: Long cheap for a reason, Citigroup’s stock now looks like a bargain, trading at a book value per share of 0.84. That’s well below peers. JPMorgan Chase (JPM) trades 1.01 times book, while Wells Fargo’s (WFC) price-to-book is 1.52. Furthermore, shares offer a 30% discount to their own five-year average on a forward earnings basis, according to data from Thomson Reuters Stock Reports.
Lower Margins: Citigroup responded to its near-death experience in the subprime meltdown by deciding to focus on its core consumer banking business. Although that’s wise from a risk point of view, it’s also less profitable than the alternatives. Net interest margin (NIM) in consumer banking — the difference between what a bank pays for deposits and charges for loans — is about 3.2%. Fixed-income trading, for example, has a NIM of about 4%.
Getting Smaller: A big knock on Citigroup is that it’s too big to manage. In response, the bank has been slimming down, shedding business and selling assets over the last several years. That’s fine for now, but not for the long run if Citi hopes to compete with sprawling domestic giants like JPMorgan Chase, as well as foreign powerhouses like Banco Santander (SAN).
Weak Dividend: Citigroup has to run its capital plans — things like dividends and share buybacks — by the Federal Reserve Board for approval, which helps explain why the payout is so stingy. Citi’s dividend yields just 0.1% (with a payout ratio of just 1%). JPM and WFC yield 2.9% and 2.8%, respectively. You don’t buy this stock for the income, that’s for sure.
Citigroup was once the bank-bailout poster boy and memories die hard. Add in years of turbulent restructuring and you can see why the market is unwilling to assign any kind of premium multiple to its stock.
Still, the bank is very much on the mend and one quarter of disappointing earnings — should that come to pass — doesn’t change the story. Even with the low earnings multiple, the stock still is up 25% for the year-to-date, beating the broader market by about 6 percentage points.
As we noted a couple months ago, if you’re bullish on equities, you have to be bullish on financials — and banks, in particular. The market doesn’t deliver sustained gains without them. That makes Citigroup a buy.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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