Citigroup Q4 Trading Woes Don't Undermine $56 Fair Value
Investors weren't quite prepared for the worse-than-expected Q4 performance figures which Citigroup ( C ) reported last Thursday, January 16 - especially after peers JPMorgan Chase ( JPM ) and Bank of America ( BAC ) comfortably beat expectations. The globally diversified banking group reported revenues which were lower than those for an already slow Q3, with the top line falling 1% compared to Q3 2013 as well as Q4 2012. The decline can be traced back to a 15% sequential decline in the bank's fixed income trading revenues (as adjusted for accounting charges from revaluation of its own debt) which fell from $2.8 billion in Q3 to $2.3 billion in Q4. Coupled with a marginal increase in provisions as well as non-interest expenses over the previous quarter, this resulted in the bottom line shrinking 17%.
Not surprisingly, the earnings release triggered a sell-off among investors - pushing Citigroup's shares lower by more than 5% within a couple of days. But we believe that investors overreacted to the bad news and missed some vital trends that hold the key to unlocking substantial value in the future. Most notable is the fact that Citigroup kept its non-interest expenses under $12 billion for the second consecutive quarter. The Q4 2013 expenses of $11.9 billion are a good 13% lower than the $13.7 billion reported for the same quarter last year. Additional good news is the continued strengthening in the bank's Basel III Core Tier 1 Capital Ratio, which rose to 10.5% - well ahead of the other U.S. banking giants (see Citigroup Comfortably Leads U.S. Peers In Basel III Readiness ).
Keeping all these factors in mind, we keep our $56 price estimate for Citigroup's stock unchanged. This figure is roughly 10% ahead of the current market price.
Declining Debt Trading Activity Clearly Hit Citigroup, But Its Peers Didn't Fare Any Better
Citigroup reports its trading revenues as a part of its Securities & Banking division, which also houses its advisory, underwriting and private banking units. The division generated adjusted revenues of $4.5 billion this quarter - 6% below the figure for Q3 and a good 35% below the $7 billion figure for the first quarter of 2013. Citigroup's top brass attributed this decline to very weak client activity in the debt market over the last quarter. And given the fact that FICC trading revenues at JPMorgan also shrank 7% in 2013, the cause is clearly not something specific to Citigroup. After all, uncertainty about the country's interest rate environment remained for a larger part of the last quarter too, with the Fed announcing the commencement of the tapering plans from January as late as December 18. ((Federal Reserve issues FOMC statement, Dec 18 2013))
That said, we recognize the impact on investor sentiments from the revenue decline, as Citigroup's trading operations contribute roughly 20-25% of the bank's total revenues, and as much as 40% of total earnings in any given period. This is why Sales & Trading figures as the most valuable business segment in our analysis for the bank as shown in the chart above - making up almost one-third of its total share value. So when the fixed income trading desk which routinely generates as much as two-thirds of the division's total revenues reports a weak quarter, one can expect a sharp decline in Citigroup's share price - similar to what we detailed earlier.
Focus On Keeping Costs Low Presents A Considerable Upside
Like we pointed out in our article How Citigroup's Reorganization Can Lift Its Share Value, Citigroup's new strategy to improve profitability by slashing costs will be key to sustainable profits in the future . In Q3 2013, the financial behemoth reported a quarterly operating expense figure of $11.65 billion - its lowest since Q2 2010. With the bank reporting a slightly higher $11.93 billion in expenses for Q4 2013, it would appear that the cost-cutting plan is working. The target of saving $1.1 billion in recurring costs by the end of the year looks well within reach now.
Another important factor here is the continued progress demonstrated by Citigroup in paring down non-core and loss-making assets housed under Citi Holdings. The bank has come far from managing roughly $900 billion worth of such assets at the peak of the economic crisis to shrink their size to $117 billion by the end of the year 2013. As Citi Holdings was established as a loss-absorbing division which has only incurred heavy losses since it was created in early 2009, the faster the bank works through these assets, the better.
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