A Compelling Case for Citigroup

S&P says the financial giant is positioned to take advantage of expanding global economies and rates the shares strong buy

by Frank Braden From Standard & Poor's Equity Research

Citigroup (C; recent price, $52) managed to top expectations with its first quarter results on Apr. 16, as it posted operating earnings per share of $1.18, well above S&P's $1.10 estimate. The report reinforced our bullish view of the shares. We think they offer a compelling risk/reward trade-off and an attractive investment over the next 12 months, due to the company's diverse business mix of capital markets, consumer and commercial lending, and retail banking, as well as earnings leverage to an expanding global economy.

Citigroup has significant room for growth, in our opinion. The world's economies are expected to grow in 2007 and 2008, and the company still has a relatively small global market share. We believe Citigroup is well positioned and has ample initiatives in place to expand into new markets and take advantage of faster-growing economies.

We also think the detailed projections and renewed focus by management make the expense-savings plan announced Apr. 11 much more credible than previous efforts. And while the expense savings are significant, we don't believe they will materially affect long-term growth. With the shares yielding 4.2%, we view them as undervalued on a total return basis. The stock carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy).

Cornerstone and Brand Identity

Citigroup divides its primary business lines into three major business groups: Global Consumer, Corporate & Investment Banking, and Global Wealth Management, in addition to one stand-alone business, Alternative Investments.

We see the Global Consumer business as the cornerstone and primary brand identity of Citigroup worldwide, accounting for about 55% of Citigroup's operating revenues and net operating income during 2006. Through its multiple consumer services, the Global Consumer franchise targets consumers and small- to medium-sized businesses throughout the world. Financial services include banking, lending, insurance, and investment services delivered through branches, loan offices, ATMs, and the Internet.

The Global Corporate & Investment Bank (CIB) includes most of Citigroup's market-sensitive businesses, and is organized into two primary business lines: Capital Markets & Banking, and Transaction Services. Capital Markets & Banking provides a broad range of investment-banking and commercial-banking services, such as institutional brokerage, advisory services, foreign exchange, structured products, derivatives, loans, leasing, and equipment finance.

Private Banking

Transaction Services provides a variety of cash-management and securities services worldwide. Through its Cash, Trade, & Treasury Services unit, Citigroup provides cash management, trade finance, and e-commerce services for corporations and financial institutions globally.

Global Wealth Management operations consist of the Smith Barney Private Client and Citigroup Equity Research businesses and the Private Bank, comprising about 11% of Citigroup revenues and about 7% of total income in 2006. The common thread running through these businesses is that they derive most of their revenues from investment income and are, therefore, highly sensitive to the direction and level of the equity and fixed-income markets.

Alternative Investments (AI) manages capital on behalf of Citigroup, as well as for third-party institutional and high-net-worth investors. AI is an integrated alternative investment platform that manages a wide range of products across five asset classes, including private equity, hedge funds, real estate, structured products, and managed futures. As of December 31, 2006, AI had $49.2 billion in capital under management, vs. $37.6 million in 2005. We expect this area to grow rapidly, as many clients look to alternative investments in order to limit risk and maximize profits.

Asian Market Focus

During the past several years, over half of the company's earnings were generated through its Global Consumer business segment, reflecting, we think, the relative strength of global consumer credit demand and spending, as well as international expansion.

Citigroup's net income from international operations represented 46% of total income, and the company plans to increase this portion to around 60% over the next several years. Apart from growth in its international consumer business, we expect the company to focus 2007 growth on investment banking, capital-markets operations, and its global wealth management division.

The company's strategies for growth in Asian markets focus on continuing to increase its core markets rapidly and investing further in China, India, and Taiwan. Citigroup views Asia as a significant opportunity over the long term. Latin America operations show good potential long-term growth opportunities, in our view. We look for continued growth from these operations through 2008.

Citigroup has recently made several moves to bolster its international operations, which we think will help drive long-term revenue growth. On April 9, 2007, the company announced its proposed acquisition, subject to approvals, of Taiwan's Bank of Overseas Chinese for $427.3 million.

International Opportunities

Citigroup is also in the middle of a tender offer for 100% of Nikko Cordial shares. On March 13, 2007, Citigroup raised its offer for Nikko 26% to 1,700 yen per share, from 1,350 yen, a day after the Tokyo Stock Exchange decided not to delist the Japanese broker in response to accounting problems. Although some of Nikko's largest shareholders said they valued the shares between 1,900 yen and 2,000 yen each, we believe the elevated offer by Citigroup has a fair likelihood of success.

We think that international markets will provide a significant growth opportunity for the corporate and investment bank, particularly within the Asia Pacific region and among emerging markets in Europe, where markets tend to be less mature. We also see opportunities in Continental Europe, where corporate capital is principally raised through bank lending and less via capital markets channels.