Banking on Citi

07/01/2005 12:00 am EST

Focus:

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

"I think that interest rates have leveled off," says Gordon Pape, along with research analyst Tom Slee, in The Internet Wealth Builder. "That’s positive for stocks and especially good news for banks." Here, they look at a favorite play in the banking sector, Citicorp.

"Citigroup (C NYSE) is paying a $1.76 dividend to yield 3.7%. Historically, Citigroup has traded at about 14 times earnings but at present it is part of the pack, priced close to 11 times this year’s expected profit of $4.20 a share. That’s cheap, especially as the fundamentals are good. This financial giant has had some problems but they are being solved. Once that’s realized, Citigroup should return to a normal valuation.

"Citigroup, formed in 1998 through a merger of Citicorp and Travelers Group, is a diversified global financial services company, but that’s an understatement. This is an enormous organization with 287,000 employees operating in over 100 countries. At heart, though, Citigroup remains a bank. More than 72% of its 2004 net income came from the consumer banking division, with 13% from corporate banking. Wealth management and insurance accounted for most of the remaining 15%. It’s a very successful bank. Earnings per share have grown an average 13.4% over the last five years.

"So why are investors staying away? First of all, the sector is out of favor. Also, Citigroup has been restructuring, always an unsettling process. In January, the company sold most of its insurance business for about $11 billion in order to focus on banking and other higher return opportunities. This led to some unusual charges for discontinued operations. The Smith Barney brokerage unit is suffering from lower client activity and the Private Bank division is incurring unusual costs as it winds down some Japanese operations. An Enron settlement cost Citigroup $2 billion (reserves had been established for this charge). There has been a drumbeat of negative news in 2005.

"In over view, however, most of these troubles are relatively superficial and are now through the accounts. Moreover, the company has been taking the interest rate adjustments in its stride and is expected to earn $4.20 a share this year, up from $4.04 in 2004, and as much as $4.60 a share in 2006. In short, Citigroup is on the move and the stock is undervalued. As a result, it represents an excellent opportunity. Buy for a target of $57."

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