Citigroup: Shares almost at new high, but still cheap (NYSE:C)

introduction

Citigroup (NYSE:C) is one of the largest banks in the world and is considered a “too big to fail” bank. I have reported on Citigroup over the years, but most recently I wrote about the 9.5% yield on preferred shares in October. Since then, the preferred stock has been cancelled and the bank’s common stock has gained more than 50%. Despite the price increase, I believe investors should consider a long position in Citigroup.

Citigroup financial results

Like any other bank, Citigroup is not exempt from interest rate changes. During the pandemic, unprecedented easing pushed the bank’s loan yields to about 0.5%, while asset yields were below 2.5%. When the Federal Reserve aggressively raised rates to combat inflation, the bank’s asset yields rose to over 6%, but loan yields also rose to over 5%. Despite the The net interest spread (return on assets less return on loans) fell to below 1.5%, but the bank has managed to reduce its leverage and keep its net interest margin above pandemic-era levels.

On the earnings side, Citigroup has observed a trend in interest income and interest expense consistent with asset and loan returns over the past five years, even as both declined slightly in the second quarter. Despite headwinds from higher interest rates, net interest income (interest income less interest expense) remains well above pandemic and pre-pandemic levels and just below the highs reached late last year.

Loans and deposits

When the regional banking crisis broke out in March last year, media reported that deposits were being drained from regional banks and ending up in “too big to fail” banks. The problem with this theory is that it is not true, especially for Citigroup. The bank has seen its deposits decline year-on-year for six consecutive quarters and seven of the last eight.

On the loan side, Citigroup has seen a rebound in loan growth after declines in 2022 and early 2023. Loan growth is currently above 4% year-over-year. One challenge with loan growth when deposits are shrinking is that it increases the bank’s loan-to-deposit ratio, which can increase the bank’s dependence on external financing and lead to earnings losses. Fortunately, Citigroup has one of the lowest, if not the lowest, loan-to-deposit ratio in the industry at 52%. Despite the increase in the loan-to-deposit ratio, Citigroup managed to reduce its long-term debt by more than $6 billion in the first half of 2024.

The risks and the future

Banks’ loan structure and performance are under scrutiny as the commercial real estate sector undergoes pandemic-related changes. Fortunately, Citigroup’s $719 billion loan exposure includes only $53 billion in commercial real estate, or just under 8% of the total portfolio. Investors should be more concerned about the bank’s $81 billion retail exposure, which has performed just as poorly as the office real estate sector over a sustained period. Fortunately, Citigroup is protected by a loan loss provision of 2.5% of gross loans, which is 90 basis points higher than the average commercial bank.

Analysts are confident that Citigroup can cut costs and increase profits. They currently estimate earnings for 2025 at over $7 per share, 21% higher than earnings estimates for 2024. For 2026, a smaller group of analysts expect earnings of over $8 per share. This puts today’s share price at just under 7.5 times 2026 earnings.

Rating compared to competitors

Despite the 50% increase in its stock price over the past year, Citigroup is still cheap compared to its peers. Based on asset size, Citigroup is one of the five largest banks in the U.S. When comparing Citigroup to its other four peers, the bank currently trades at the lowest price-to-earnings ratio, but that’s not the most striking comparison. When looking at the price-to-book ratio, Citigroup is well below its peers. If the turnaround succeeds and Citigroup grows its earnings, the bank’s shares will start to converge with its peers and share price growth should outpace earnings growth.

Diploma

Citigroup’s conservative balance sheet will be the cornerstone of its earnings growth over the next few years. The bank has enough loan diversity to weather a storm and enough loan loss provision to protect earnings. A low loan-to-deposit ratio will allow it to fund its loan growth with lower interest rates as demand increases. Its cheap valuation relative to peers is the icing on the cake. I expect Citigroup to succeed with its turnaround initiatives over the next three years and that shareholders will be the primary beneficiaries.