Dessauer "Banks" on China...

02/10/2006 12:00 am EST


John Dessauer

President, John Dessauer Investments, Inc.

"China is a huge opportunity," says John Dessauer, editor of Investor's World. But his favorite play on China is not based there. Rather, it is banking giant, Citicorp, which he feels is poised to benefit as Beijing addresses problems within China’s banking sector.

"Citigroup (C NYSE) is one of the most profitable banks in the world. Last year, Citigroup earned $7 billion in the fourth quarter alone, and more than $24 billion for all of 2005. Fourth quarter profits were 30% better than a year earlier, but Wall Street punished the stock. Why? Profits in the US consumer banking business were down 23%, due mostly to a change in US bankruptcy laws. But when the fourth quarter is stripped of one-time items, operating earnings were $0.98 a share, near Wall Street’s $1 per share estimate.

"Instead of celebrating Citigroup’s ability to offset the one-time bankruptcy hit, Wall Street panicked once again. Late last year, many Americans rushed to file for bankruptcy ahead of the strict changes in the law. That cost Citigroup $252 million in losses. As a result, net income in credit cards fell 60% to $444 million. That blow won’t be repeated. Citigroup’s credit card profits will return to normal this quarter, and the good news from last quarter will also continue.

"In the final quarter of 2005, Citigroup enjoyed strong growth in investment banking, as well as consumer banking in Asia and Latin America. These strengths more than offset the one-time hit from the new bankruptcy laws. Wall Street’s subdued estimates for this year are $4.20 to $4.50 a share, pricing the stock at 11 times earnings. In 1999, Citigroup earned $2.15 a share, and 2004 earnings were $4.04. What if Citigroup can match that 88% growth again? By 2010, earnings would be more than $7.00 a share, and the stock would likely trade at $95, a double. Plus, there is the $1.96 (4.1%) dividend, which was just raised 11%.

"Here’s where the China story comes in. China has its strengths, but China also has weaknesses. One major weakness is banking. Chinese banks are awash with bad loans, and fixing the banking mess is a top priority in Beijing. This makes banking in China a huge opportunity for us, and Citigroup is best poised to profit in China, with its burgeoning consumer base. Consumer banking is Citigroup’s strength.

"China has restricted foreign ownership of Chinese banks, but Citigroup is going for an exemption by bidding for 85% of Guangdong Development Bank. Guangdong is a consumer banking powerhouse with enormous problems in bad corporate loans. Bad loans could amount to $6.2 billion, too much for the Chinese government to handle. Citigroup argues that it has the people and expertise to deal with bad loans if it can have free reign in managing Guangdong Bank.

"This looks like a win-win deal. China’s politicians can solve a major issue, take credit for the success, and open the door for more deals. A Citigroup success would increase the value of other Chinese banks. My bet is that Citigroup and its partners will win approval and gain control of Guangdong Development Bank, its profitable consumer banking business and its 520 branches around China. With one stroke, Citigroup will become a major China play. Success in China will help Citigroup grow earnings faster than I now expect. Meanwhile, we have a 4+% dividend and a depressed stock. Citicorp is a low-risk, high-potential investment. Buy."

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