Friday, April 07, 2006

Banking on Citigroup's Shares

As Stock Price Trails Indexes, Some Investors See Value and Bet On Firm's Long-Term Outlook

The Wall Street Journal, Ian McDonald and Clint Riley, 7 April 2006

When it comes to its share price, Citi is looking decidedly small town these days.

After sliding about 7% over the past two years -- compared with a 15% gain for the Standard & Poor's 500-stock index and 7% for the Dow Jones Industrial Average -- shares of Citigroup Inc. are cheaper, meaning they trade at a lower multiple of their expected per-share earnings, than the stocks of smaller peers in banking, capital markets and consumer lending, which are the company's biggest businesses globally.

By that same measure, the financial-services company's stock also is more than a third less expensive than its average price over the past decade, according to researcher Capital IQ.

In 4 p.m. composite trading yesterday on the New York Stock Exchange, Citigroup's shares were down 41 cents, or 0.85%, to $47.85, giving the company a market value of $241 billion. It has $1.5 trillion in assets.

The rough patch for the stock, once a favorite among growth and value investors alike, is partly driven by the general concerns affecting all banks: that rising rates and a slowing economy will pinch profits. More specifically, some investors worry that Citigroup is too big to expand meaningfully, especially since Chief Executive Charles Prince has become more selective about making acquisitions.

While Mr. Prince has talked of eschewing big deals, he received such flexibility this week when the Federal Reserve lifted its roughly yearlong ban on "significant" acquisitions, which was slapped on Citigroup after a string of dust-ups with regulators.

Its shares are trading at just 11 times this year's expected per-share earnings, about the same as Bank of America Corp.'s per-share multiple, and slightly cheaper than J.P. Morgan Chase & Co.'s 12.5, according to Thomson Financial. So, it is getting tough for Wall Street and big investors to ignore the opportunity, especially since Citigroup raked in profits of more than $5 billion each quarter for the past year and a half. "It's tantalizing," says Michael Holton, manager of the $400.6 million T. Rowe Price Financial Services Fund, which holds Citigroup shares.

Others agree. "Really and truly, it's hard to see what the big downside could be for Citi at this point," says Craig Woker, an analyst who covers the company at Chicago researcher Morningstar Inc. and estimates that Citigroup's shares are worth $54 each.

There are three ways an investor makes money from owning a stock: rising earnings that boost the share price, dividends that the shareholder can pocket or use to buy more shares and a rising price-to-earnings multiple. Fans of Citigroup say there is a good argument that the bank can deliver on all three fronts.

Morningstar's Mr. Woker projects mid- to high-single-digit earnings growth for the company in coming years. Overall, analysts project 10% earnings growth over the next five years, according to Thomson Financial.

Mr. Prince has changed the company's strategy since taking the CEO reins from his mentor and departing Chairman Sanford I. Weill in the fall of 2003. His aim: To reinvest in existing units rather than buy up competitors, focusing on being a global distributor of financial services.

In the U.S., the company just launched an Internet bank aimed at luring customers with high-yielding savings accounts to battle similar offerings from competitors like ING Groep NV and HSBC Holdings PLC. And it is expanding its retail-branch network. At the same time, several analysts have said they expect Citigroup's corporate and investment bank to show strong profits in the first quarter from its trading operations and fees from equity and debt underwriting.

Despite its size, it can be argued that Citigroup has room to grow, particularly overseas. The company currently has a little more than 2% of the international market for financial services. Citigroup's bid for Turkey's Finansbank fell through this month, but it has also made a $3 billion bid to take majority control of struggling Guangdong Bank in China.

"If I didn't think the company's fundamentals would begin to improve over the next two years it would be easy not to own it," says T. Rowe Price's Mr. Holton. "At the same time, you're getting paid pretty well to wait."

The company's dividend yield is more than 4%, higher than the 10-year Treasury bond's yield after taxes for many investors. Citigroup also spent nearly $13 billion on share repurchases last year, dropping its share count, but failing to boost its share price.

Given those ample payouts to shareholders, even modest earnings growth would likely relax critics and bring the stock's P/E multiple back up to its historical range -- and raise the stock's valuation closer to historical levels.

"Chuck Prince hasn't totally won the Street over," but skepticism, which might be overblown, is reflected in the current price, says James Schmidt, manager of the $938.6 million John Hancock Financial Industries Fund, in which Citigroup was the fund's second-largest holding at the start of this year.

Others are banking on a rise for Citigroup's shares, too. Los Angeles-based Capital Research & Management Co., manager of American Funds, bought more than 29 million shares in the fourth-quarter, according to regulatory filings. The firm is Citigroup's second-biggest shareholder, behind Barclays Global Investors.

What could chill investors' affection for Citigroup further?

A serious dip in global economic growth or a big bump in consumer bankruptcies would hurt. As would a scandal akin to those involving allegations of illegal bond trading in Europe and the irregularities that led to the shuttering of Citigroup's private-banking operations in Japan. Last week, Australian authorities accused the firm of insider trading, charges that Citigroup says it will "vigorously defend."

But most analysts see such prospects as remote. Fourteen of the 20 buy-side analysts who currently follow Citigroup rate the company as either a "buy" or a "strong buy." The remaining analysts rate the company a "hold."