Citigroup Stock Upgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and “initiate coverage” on a few more. But do these analysts even know what they’re talking about? Today, we’re taking one high-profile Wall Street pick and putting it under the microscope…

Pity Citigroup (NYSE: C) shareholders.

After enjoying a strong 27% surge in stock price in 2017 — despite losing money as a result of tax reform — Citi shares have fallen upon hard times in 2018. As of this morning, Citigroup is down 17% from its Jan. 26 high, writes Deutsche Bank in a new upgrade on (requires subscription) this morning.

And that’s OK.

As Deutsche explains, Citigroup’s troubles are mainly due to “macro factors” beyond its control, and temporary in nature. In contrast, moves Citi has been making to fix what it can — for example, by strengthening its balance sheet — could bring a revival in the stock as early as tomorrow.

Here’s what you need to know.

Image source: Getty Images.

The stress test cometh

June 21 is the due date for the first installment of data from the Federal Reserve on the latest round of stress tests it’s conducted on America’s big banks, designed to ensure they can survive the effects of any big financial crises that may arise. On June 28, the Fed will release data from its Comprehensive Capital Analysis and Review (CCAR) of these same banks — giving Citigroup shares two chances to benefit from a positive review.

And Deutsche Bank predicts that Citi’s results will be viewed positively, because “expectations on cost efforts have been lowered enough that they don’t see further disappointment,” writes StreetInsider. Furthermore, because dividend hikes and share repurchase announcements have tended to follow positive stress test results in the past, there could be good reason to hope for follow-on good news after the stress test results come out.

What’s lowering the expectations?

But why is this expectations bar being lowered? This goes back to the “macro factors” that Deutsche cited at the outset.

Rising U.S. rates, a strengthening U.S. dollar (which makes U.S. goods and services relatively more expensive abroad), trade uncertainty (from President Trump’s continuing trade war), and weakening emerging markets have all combined to sour investors on banks’ prospects, making it easier for banks like Citi to exceed expectations.

At the same time, Deutsche notes that sentiment surrounding Citi specifically is being depressed by worries that the company’s “trends in credit card” are looking “mixed,” while Citi has also experienced delays in cutting its costs and boosting its efficiency.

What Citi has to say about that

That all actually sounds like bad news for Citigroup, though. So why does Deutsche see it as a reason to buy Citigroup stock? Why is Deutsche upgrading Citi stock to buy, and assigning the stock a higher price target of $76 a share — 12% higher than where those shares trade today?

For some answers, let’s go back to Citi’s Q1 earnings release, and management’s conference call with analysts discussing those earnings.

Citi reported $1.68 per share earned on $4.6 billion in revenue in its fiscal first quarter — 24% growth in profits year over year, on a 3% rise in revenue. The company’s efficiency ratio was “just under 58%.” (Foolish banking analyst Michael Douglass says anything “under 60% is pretty good.”) Citi’s return on tangible common equity was 11.4% and its return on assets was 0.98% — numbers that compare well to the industry average. (Michael reminds that “the industry benchmarks are a 10% return on equity and a 1% return on assets.”)

Those numbers all argue pretty favorably for Deutsche being right about Citi winning a Fed seal of approval in tomorrow’s stress test results.

As far as the comments on credit card trends go, it’s true that Citi’s U.S. branded cards business grew revenue only 2% in Q1, and thus slower than the bank’s overall revenue growth. Still, management said it experienced “acceleration” in “interest earning balances” on the cards it issues last quarter. It’s also “still getting growth in net interest revenue in U.S. branded cards ex-Hilton” (which card portfolio Citi has sold). Globally, the company is enjoying “continued growth in loans and purchase sales in every region.”

While that may qualify as “mixed” news of the credit card front, as Deutsche characterizes it, on balance I see more positives here than negatives.

Valuing Citigroup

Most important to me, though, is the value I’m seeing in Citigroup stock today. Despite carrying a market capitalization of $170.3 billion, Citi currently has no P/E ratio because its trailing earnings are still weighed down by the losses attributable to tax reform last year. That being said, analysts polled by S&P Global Market Intelligence on average expect Citi to earn $6.50 per share in profits by the end of this year, and grow that number to $8.48 by 2020.

Assuming Citi earns what it’s supposed to this year, I get a valuation of about 10.4 times current-year earnings on the stock, and a growth rate of roughly 15% per year over the next couple of years. That seems to me a very fair price to pay for so much growth. On top of that, Citigroup is paying a 1.9% dividend yield, which is a nice sweetener to an already attractive valuation.

Deutsche Bank is right to recommend Citigroup stock.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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