Why Citigroup’s Stock Is a Top Pick

Citigroup C is in the middle of a major turnaround and remains a complex story. The bank is working through consent orders from regulators, selling off its international consumer operations, and refocusing on its wealth unit. This should make Citi easier to understand and structurally more focused, but we think it will still trail its peers from a profitability standpoint and struggle to outearn its cost of capital. The wealth and card markets remain as competitive as ever, and we don’t see the bank building up a retail presence to rival its peers. While Citi’s issues are real, we still see room for an improved valuation. The bank will need to prove it can bring core costs down after 2023. If we see this, some growth and profitability out of the institutional clients group and cards, and any momentum in wealth, Citi has a path toward earning its cost of capital.

Key Morningstar Metrics for Citigroup

• Fair Value Estimate: $75
• Star Rating: 5 Stars
• Economic Moat Rating: None
• Moat Trend Rating: Stable

Economic Moat Rating

We believe Citigroup has no economic moat. We expect the bank to struggle to meet our assigned cost of equity of 10%, even by the end of our forecast period. While the institutional clients group has a global presence uniquely positioned to serve multinational corporations, the expense associated with maintaining this international presence across many legal jurisdictions and the latest increase in regulatory costs points to more limited profitability potential. The personal banking and wealth management segment has historically been more profitable, but it also has less profitable card operations than peers, a limited U.S. retail banking presence, and a limited wealth unit. As such, Citi is currently underearning its cost of capital, and we think it will be difficult to structurally change this set of business units in a way that gives us confidence in the bank’s ability to outearn its cost of capital in the future.

Read more about Citigroup’s moat rating.

Fair Value Estimate for Citigroup Stock

After incorporating the latest earnings results, we are maintaining our $75 fair value estimate. This incorporates a mild recession toward the end of 2023 and into early 2024 and slight adjustments elsewhere to our model (primarily upward adjustments to net interest income and expenses). Our fair value estimate is equivalent to 0.9 times tangible book value per share as of December 2022. We forecast that most noncore units will be sold off by the end of 2023. We assume Citigroup takes the maximum loss of $2 billion from its exposure to Russia and receives $7 billion for its Mexico consumer unit for a net adjustment of $5 billion (approximately $2 per share). We assume no value generation from the sale of the bank’s Asia consumer units.

Read more about Citigroup’s fair value estimate.

Risk and Uncertainty

An investment in Citigroup entails a large amount of regulatory and macroeconomic risk. Compliance costs are high, the company is large and complex, and the bank is a prime target for regulators seeking fines and litigants seeking compensation for alleged misdeeds. From a macroeconomic perspective, the bank’s profitability will be affected by the interest-rate cycle and the effects of credit and debt cycles, none of which are under management’s control. Most lines of business at Citigroup are economically sensitive. The bank is also subject to the Federal Reserve’s annual stress test. Citigroup’s international presence is another source of risk and one that is unique compared with its peers. A final risk is business disruption, with the banking industry going through more technological change than ever before.

Read more about Citigroup’s risk and uncertainty.

Citigroup Bulls Say

• Citigroup is in the middle of a strategic repositioning, making major moves such as selling off its consumer business in Mexico and reinvesting in its strong points: investment and corporate banking and wealth. Citi may finally emerge as a structurally improved franchise.
• Simplifying the business and selling off noncore units should help Citigroup free up extra capital and derisk the business, which should lead to an opportunity for share repurchases and a lower required discount rate.
• The shares trade at far less than tangible book value, not a hard hurdle to clear.

Citigroup Bears Say

• Management doesn’t expect to hit its return targets until two to four years from now, and the bank has historically underperformed. Is it worth it to wait around that long?
• Citigroup is a complex story with many moving parts, increasing the difficulty in predicting what its final version will looks like.
• Citigroup's returns and revenue growth will be lower than peers', and there remains room for negative surprises on expenses as the bank invests in regulatory and growth initiatives.

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