Citigroup: Too Cheap To Ignore Heading Into Earnings

Investors who picked the lows in Citigroup Inc. (NYSE:C) and did not fear a further contagion in the banking sector should pat themselves on the back.

Market operators also have concurred, as C formed a formidable bear trap or false downside breakout, taking out panic sellers at C's March lows before reversing the selling momentum remarkably.

Hence, we assessed that buyers returned strongly, seeing the recent valuation dislocation in C as an opportunity to take advantage of the cheapest stock among its leading banking peers.

C's valuation metrics Vs. peers. Data source: S&P Cap IQ

As seen above, C last traded at a TTM tangible book value per share or TBVPS multiple of just 0.57x, well below its leading G-SIB peers above. It's also below its 10Y average of 0.88x, even as Citigroup expects to progress well in its transformation efforts under CEO Jane Fraser.

However, the dislocation is not apparent from C's valuation against Wells Fargo, as seen above, as they trade at a similar NTM normalized P/E. Hence, it's clear that market operators remain skeptical about the bank's ability to improve its ROE and RoTCE significantly to justify an upward re-rating.

Morningstar also classified Citigroup without an economic moat (not even narrow), which is a clear deviation from its other three peers. Accordingly, BAC, JPM, and WFC received the highest wide moat rating, justifying their ability to defend their profitability and earnings sustainability.

However, the assessment of Citigroup's ability to drive significant earnings growth wasn't encouraging, as it added:

The bank's business mix is structurally disadvantaged compared to its money center peers, leading to limited profitability potential. The expenses associated with maintaining an international presence across many legal jurisdictions and the increase in regulatory costs further limit profitability potential. - Morningstar

Does it make sense? Well, C has consistently traded at a considerable discount against leader JPMorgan over the past 10 years.

We think the market has gotten it right so far. JPM reported a ROE of 14% for FY22 and is expected to report an ROE of 13.9% this year. In contrast, C reported an ROE of 7.7% in FY22 and is projected to report an ROE of 6.05% for FY23.

As such, the transformation for Citigroup will need time for management to prove its worth, which requires investors to remain patient as the bank executes through 2026.

Investors assessing the opportunity to buy ahead of its upcoming earnings release on April 14 should consider looking beyond Q1. Why? As the market is forward looking, coupled with the possible downward earnings revision for FY23 and FY24, we believe investors have reflected these headwinds at its current valuation.

Citigroup is still expected to report a QoQ increase in its normalized EPS for Q1. Accordingly, C is estimated to post an EPS of $1.67, up 44% QoQ. Despite that, it represents a 17.4% YoY decline.

Analysts have continued downgrading banks' earnings projections through March 2023, suggesting they are modeling for worse outcomes.

However, C's TTM P/TBVPS valuation of 0.57x is close to the two standard deviation zone under its 10Y average. It indicates that the market's expectations over C remain in the highly pessimistic zone relative to its peers.

As such, we believe it should support a potential outperformance thesis if management doesn't provide a highly disappointing outlook for its upcoming release.

C remains in a long-term downtrend against JPM. Moreover, that trend doesn't appear to be in danger of being overturned.

Hence market operators continued to take advantage of rips in C by rotating out (such as in January) when it outperformed JPM momentarily.

Despite that, we assessed that the mean-reversion opportunity for C/JPM against its secular downtrend is still valid, as the rip has yet to occur.

However, investors must be cautious as C/JPM closes in against its January resistance zone, which saw a bull trap previously.

Hence, investors looking to exploit the dislocation in C should consider acting more urgently if they're confident that the market has priced in considerable disappointment for its upcoming earnings call.

Rating: Buy (Reiterated).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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