Citigroup (C) earnings were so surprisingly good that Citigroup stock hit a six-year high, and like Bank of America (BAC) yesterday, this quarter could very well mark a turning point for the bank.
Banks like Citigroup and BAC have struggled under the weight of legal and regulatory costs ever since the financial crisis. Now, the banks are racing to slim down in an era when near-zero interest rates and new regulations make revenue growth much harder to come by.
But as we saw with BAC last Wednesday, these long-troubled banks have put the crushing weight of fines and settlements largely behind them, and that makes for much more buoyant bottom lines.
Indeed, Citigroup earnings hit their highest level since the financial crisis. As with BAC, the keys were an end to giant legal bills and the cost-saving benefits of getting smaller.
Now that its free from the burden of litigation expenses, Citigroup is set for easy year-over-year comparisons.
For the most recent three-month period, Citigroup earnings came to $4.85 billion, or $1.51 a share, and legal and repositioning costs were just $421 million.
In last year’s second quarter, net income was just $181 million, or 3 cents a share, because Citigroup took an accounting charge of $3.8 billion for legal settlements.
Analysts, on average, forecast earnings of $1.34 a share, according to a survey by Thomson Reuters. Adjusted earnings — what the market actually cares about — were $1.45 a share, which explains why Citigroup stock rallied hard on the news.
That’s a big earnings beat.
Citigroup Earnings Deserve Higher Multiples
Lower legal expense is just one way in which Citigroup earnings enjoyed some relief. Like every other bank in the industry, Citigroup is cutting costs and reducing its global footprint by selling retail operations in numerous countries. The bank is also paring its network of U.S. branches and getting out of non-core businesses.
Despite carrying big upfront costs, restructuring initiatives eventually lead to savings, and that is what’s happening at Citigroup. The drop in legal costs and savings from restructuring led to a 30% decline in operating expenses, good for a 7% drop on an adjusted basis.
That’s partly why Citigroup earnings beat Wall Street estimates despite revenue going nowhere. After all, on an adjusted basis, the top line slid 1.5% to $19.16 billion, although it was enough to squeak by analysts’ average projection of $19.11 billion.
The Citigroup earnings report leaves no doubt that its transformation into a smaller, more profitable bank is working — and the market should take notice.
Citigroup stock’s valuation needs to expand in order to reflect recent progress. A price-to-book value of o.85 and a price-to-earnings ratio of 9.9% were appropriate when Citigroup was in poor health, but after Q2 earnings, investors shouldn’t complain about paying a little more for Citi stock.
Like BAC, Citigroup is still walking with a limp, but a bit of multiple expansion is in order.
That bodes well for more upside in Citigroup stock.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
