Implications Of The Citigroup (C) Deal
This morning before the market opened, Citigroup (C) announced their earnings. More on that in a minute, but at the end of last week came news that may well be even more significant. Multiple reports suggested that the financial giant may be close to a settlement with the U.S. justice department in the ongoing saga of mortgage backed bonds that went bad in the financial crisis.
The $7 billion settlement that those reports alluded to was confirmed by the bank this morning, but at the risk of sounding cynical I would suggest that the actual amount is not particularly relevant. The fact that settlement has been reached is key and clears the way for shares in Citigroup to finally follow their peers in the financial sector and make substantial gains after underperforming over the last year.
Of course not having a settlement in place is not the only thing that has held back shares in Citigroup. They have also had problems in Mexico and have missed estimates on earnings two of the last three quarters. The earnings this time around, after you strip out the effects of the settlement, were a big improvement with a beat on both the top and bottom lines. The issue in Mexico is more worrying to many, though, as it suggests that the corporate culture that enabled the problems leading to the financial crisis is still festering at the bank. With a new CEO, however, and a revamped and beefed up compliance division it looks as if there are real attempts to address that situation.
On the plus side, this morning’s results indicated significant growth in the bank’s core lending businesses; a good sign for the future. They also reported a stronger balance sheet, with the Tier 1 Common Capital ratio of 10.6 percent on a Basle III basis, and an increase in tangible book value, the overall worth of the business. The disconnect between that book value and the price of the shares is a large part of why many see Citigroup as one of the best value stocks around. Before this morning’s events the market was valuing the company at less than three quarters of book value. This does suggest value, but there was the overhang of the unknown settlement with the DOJ.
Now that that is quantifiable the ratio of price to asset value will even out some, but every other indicator of value suggests to me that Citigroup may be not just the best value in the financial sector, but quite possibly one of the best value stocks around period. Given the transition that is occurring in the industry multiples are generally low for large banks, but Citi’s forward P/E of 9.1 (at Friday’s close) still compares favorably to, for example, Bank of America (BAC) at 10.4 or Wells Fargo (WFC) at 12. If growth is factored in by using the PEG Ratio, then Citi’s value is even more evident. A low number indicates value when the Price to Earnings growth ratio is calculated, and at 0.92, Citi’s PEG is substantially more attractive than either BAC or WFC, at 1.9 and 1.29 respectively.
Of course, while the relative value is evident there are certain things that you must believe or accept if you are to see Citigroup as a decent investment. First and foremost you have to believe that management is sincere in its efforts to change that corporate culture, and then you must be able to forgive past sins. If you can do both of those things, then buying Citigroup, even after today’s pop, looks like a good bet.