Turnaround Letter Buy-rated Citigroup (C) reported a healthy 12% increase in adjusted per-share earnings ($1.83), driven by a modest 2% increase in profits and a healthy 10% decrease in share count. Earnings beat the $1.80 consensus estimate. Despite their recovery from the sharp year-end sell-off, the shares are still undervalued.
Citi shares were flat in early trading, as the bank’s profit growth is being driven by a lower share count rather than by organic growth. While the return of capital from share buybacks is impressive, the bank needs to show that it can increase profits without share count reductions to earn meaningfully higher earnings and book value multiples.
Revenue growth was modest at 2%: Consumer segment revenues grew 3% while Institutional segment revenues were flat due to weak deal fees and trading profits.
Expenses fell 2%, reflecting CEO Michael Corbat’s emphasis on more efficient operations. Consumer segment expenses were flat while Institutional segment expenses fell 2%. We expect continued progress with Citi’s expense improvements.
Credit costs, while still low, rose 16% led by North American credit card losses. However, it appears that the bank is writing off bad loans more quickly, building more reserves, and seeing a less favorable effect from foreign exchange, rather than experiencing a large increase in bad loans. Its loss reserves are now higher as a percent of both non-performing loans and total loans. And, its non-performing loans are lower as a percent of total loans.
Overall, the Consumer segment is doing reasonably well (if not stellar). Segment loans, deposits and profits (+11%) are moving in the right direction. The Institutional segment, however, is not – its volatile and lackluster growth is dampening the Consumer segment’s strength.
Despite returning $4.6 billion to shareholders in the quarter (dividends plus repurchases), which was 103% of the quarter’s profits, Citi’s capital ratios were unchanged from the prior quarter. Compared to a year ago, these ratios were a tad weaker. The bank is slowly but surely increasing its book value per share (tangible book value is now $67.64, up 10% from a year ago).
Citi is moving toward its ROTCE (return on tangible common equity) ratio of 13.5% by 2020, as it achieved a 11.9% rate this quarter, more than a percentage point higher than a year ago. We believe that the bank can reach this target. Citi will continue its hefty share repurchases and dividends, buttressing its value to shareholders.
While its shares have recovered from their sharp year-end sell-off, they are still undervalued. At $72, they trade at a very modest 6% premium to its tangible book value per share, a 9% discount to its straight book value per share, and at 9.6x earnings.
We continue to rate Citigroup (C) shares a BUY with a price target of $85.
Disclosure Note: An employee of the Publisher owns C shares.