Markets & Finance

A Citi Worth Buying


By Stephen Biggar Citigroup's (C) size and scope are unparalleled. The diversified global financial-services giant serves 192 million customers and operates in more than 100 countries. Its subsidiary companies include familiar names such as Citibanking, Salomon Smith Barney, Travelers Life & Annuity, and Student Loan Corp.

But Citi's shares have declined along with the broader market in the past few years and are now nearly 30% below their high reached in mid-2000. And that presents an opportunity for investors: S&P believes the stock is now trading at a compelling valuation. Citigroup carries S&P's highest investment recommendation of 5 STARS (buy).

Its operations are divided into four main segments: global consumer, global corporate, global investment management, and investment activities.

93 MILLION CARDS. The global consumer segment (which accounted for 48% of net income in 2001) is itself divided into three businesses. Citibanking delivers banking, lending, and investment services to customers through 445 branches. The cards unit offers MasterCard, Visa, and private-label products with 93 million accounts and $109 billion of managed receivables as of 2001 yearend. CitiFinancial provides community-based lending such as real estate-secured loans, unsecured and secured personal loans, and auto loans through more than 2,200 offices in North America.

The global corporate segment (38%) provides investment advice, financial planning and retail brokerage services, banking and other financial services, and commercial insurance products. The segment includes investment banking and commercial banking services such as the underwriting of fixed-income and equity securities, and capital raising, advisory, research, and other brokerage services.

Citigroup's third main segment, global investment management and private banking (10%), includes Travelers, Citigroup Private Bank, and Citigroup Asset Management. This segment (4%) mainly comprises Citi's venture-capital activities.

SAVVY SPIN-OFF. Our belief at S&P that the stock presents an attractive opportunity is centered on three premises: stabilizing trends in credit quality and capital-markets activities, a reallocation of Citi's capital to higher-growth businesses following the spin-off of its Travelers Property Casualty unit, and a shift to retail-related businesses.

Citigroup spun off 23% of its Travelers Property Casualty unit in March, 2002, recognizing a $1.1 billion gain. It plans to distribute all but 9.9% of Travelers to its shareholders by yearend. We at S&P believe that, initially, shareholders had some concerns about the strategic move Citigroup was taking in spinning off Travelers, and that had a somewhat depressing effect on the stock price.

However, we view Travelers as a mature, low-growth business with substantial capital requirements and the prospect of catastrophic losses. In addition, cross-selling efforts, which were a large part of the rationale for merging Citicorp banking and Travelers insurance operations, did not prove particularly enticing in the property-casualty business. Citigroup is retaining the life insurance and annuity operations of Travelers, where cross-selling offers more compelling opportunities for banking customers.

CALIFORNIA GOLD? Some of the spin-off's proceeds are being used to acquire Golden State Bancorp (GSB), which owns California Federal Bank, in a $5.8 billion cash and stock deal. We view this transaction as a positive for Citigroup, since it fits with its strategy of expanding the proportion of revenues derived from its global consumer business, specifically the retail franchise.

The deal gives Citigroup the fourth-largest share of deposits in California and adds a solid prime national mortgage business, as well as the ability to expand GSB's customer base and product offerings. At only 11 times 2002 earnings for GSB and under three times book value, the purchase price allows the deal to immediately add to Citigroup's earnings.

Credit quality has been an industry concern for the past 18 months, with a high level of consumer bankruptcies, turmoil in Latin America, and several Chapter 11 filings by high-profile companies (including Enron, Kmart, and Global Crossing) leading to rising net charge-offs of bad debt. However, we believe the risks here are more macroeconomic in nature -- Citigroup is no more exposed to credit quality risk than the industry at large. Its capital reserves remain adequate, in our opinion, to weather a modest additional downturn in economic conditions.

SIGNS OF STABILITY. And Citigroup remains more diversified by customer, product, and geography than any financial-services company, which will help minimize wide swings in credit quality. Our broader view of credit quality is that it will see modest additional deterioration through yearend, several quarters beyond the recent economic improvement and in line with the typical status of credit quality as a lagging economic indicator.

Although we don't believe Citi's capital-markets operations -- its investment banking, brokerage, venture capital, private equity, and trading businesses -- will rebound in the next several quarters, these operations have shown signs of stabilization. In addition, they're well positioned to take advantage of an eventual recovery in global equity markets.

Much of the growth in our overall profit outlook comes from the global consumer segment, where Citibanking, credit cards, and CitiFinancial are likely to be among the primary growth drivers. Substantial margin improvement, efficiency gains following the recent integration of Associates First Capital, and healthy growth in credit-card receivables from still-strong consumer spending are expected to continue.

UNWARRANTED DISCOUNT. At S&P, we believe the stock's valuation is compelling, based on the June 7 closing price of $41. Citigroup shares have historically traded at about 75% of the price-earnings multiple of the S&P 500. We believe the current discount -- it's now trading at 55% of the 500's p-e -- is unwarranted. We would argue that the stock deserves a higher p-e multiple based on its earnings growth vs. that of the S&P 500 overall.

Citi's consistency of earnings growth through a wide range of operating environments is another plus. Earnings grew at a compound annual growth rate of 21% from 1997 through 2001. Citi's share price, meanwhile, has changed little since mid-2000 and is down 16% since the start of 2002.

S&P sees earnings growth of 18% in 2002 (after a depressed 2001), to $3.25, and 14% in 2003, to $3.70, even assuming a continued lackluster environment for capital-markets activities and credit quality. Consistent double-digit earnings growth is enviable in the current economic environment. The shares currently trade at 13 times our 2002 estimate.

Given that investor worries about Citigroup are subsiding, including credit-quality issues and its deployment of proceeds from the Travelers spin-off, we assume that the stock will return to a p-e multiple of around 17 -- and that brings us to our target price of $55, or around 34% above the June 7 close. Analyst Biggar follows banking stocks for Standard & Poor's


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