Alastair Macleod is portfolio manager at Wingate Asset Management and has specialised in international equities for the past 11 years.
How long have you held Citigroup?
Since April 2014 – consistent with our contrarian process, we became interested in the stock following its failure in late March 2014 to gain the US Federal Reserve’s approval to implement its planned capital return to shareholders.
The Fed’s decision related to perceived deficiencies in policy and procedure, as opposed to any concern regarding the capital adequacy of the bank. We believe this issue significantly distracted the market from the broader operational improvements management implemented across the bank, most notably in credit, capital and costs.
What do you like about it?
In banking, the sources of risk primarily revolve around capital, funding and credit. Revenue growth and cost control are more relevant from a return rather than risk perspective. Citigroup was historically undercapitalised and exposed to large credit risk by way of overexposure to exotic CDO type instruments. Now it is a very different business from both a capital and credit perspective. For example:
- Citi Holdings (the company’s ‘bad bank’) has declined from approximately $700 billion in assets to $122 billion;
- The bulk of Citi’s GFC related litigation costs have been settled;
- Tier 1 capital has increased from 7.2% in 2012 to 11.0%.
How is it better than its competitors?
The capital position of the bank is the strongest it has been for many years, with strong growth in its core markets. As the historic underperforming loans contained within Citi Holdings diminish, group profitability is also likely to structurally improve. With other US peers trading at an average 1.4x tangible book value, we believe Citi’s valuation will be re-rated upwards in conjunction with an increase in book value.
What do you like about its management?
Often following a financial crisis, management teams become inward looking and seek opportunities to boost returns through efficiency improvements, as opposed to more risky acquisitions or inorganic revenue growth. This is the case with Citi’s management, which now has an obsessive focus on internal self-help. This is evidenced by Citi’s exit from 12 small non-core countries, a reduction in card products from over 800 to 400, and consistent reductions in core operating costs every quarter for the past few years.
What is your target price on Citibank?
Our target price is $US63. This represents the bank trading at 1x tangible book value, which is a conservative assumption should underlying returns continue to improve to 10-11%. Going back it is difficult to find examples of large, diversified, well capitalised banks, with growing assets, and +10% returns on equity trading on less than 1x tangible book.
At what point would you sell it?
As the stock price approaches, our valuation and the margin of safety declines, we would commence trimming our position. However, as the book value is growing 7-8% a year, our assessment of intrinsic value is also increasing (e.g. at year-end 2016, we estimate tangible book value will be $US68).
How much has it added (subtracted) to your overall portfolio over the last 12 months?
Citi has been the second largest contributor to the fund’s returns over the past 12 months. The stock has appreciated by over 12% in US dollars, or over 30% in Australian dollars, and contributed a total of 1.6% to the fund’s 19.1% total return in Australian dollars over the past 12 months.
Is it a liquid stock?
The stock is highly liquid and has a market cap of over $US160 billion.
Where do you see the value?
Citi is an extremely diversified business, with a balance sheet that has never been stronger. With its equity trading at a discount to tangible book value, we see little downside risk at the current share price.
As the historical concerns over regulatory fines and its capital base subside post-GFC, robust book value growth seems highly likely, with the profitability on that book also improving.
A more normalised interest rate environment – a question of when and not if in our view – represents potential for further profitability uplift, and is not priced into market expectations.
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