Citigroup (NYSE: C) Report | Update
Hi, short update.
I’m trying not to be a hermit like I was to you guys back at the start of the year. It’s one of those times where when it rains it pours. I just finished writing up Citigroup and bought the stock (and I’m likely to buy more, probably by selling some GM and BAC).
I need to write the PG-13 version so that it reads more accessibly to more of you, and cut it to ~30 mins. I haven’t gotten to this yet because another stock idea hit me in the face while I was finishing Citi.
It’s a special situation investment and you can’t leave these ones. I think either this stock is a 2-3.5x, or if the management doesn’t fix it, it’s going to get acquired by a competitor or a private equity firm. It should take only 3 years for one of these to happen. Several competitors have already been bought up in the last 5 years, and the publicly traded ones are also acquisitive, consolidating the industry. This company is vastly underperforming in terms of margins and capital productivity, and it’s soooooo easy to fix. It got spun out of a much larger company, which clearly didn’t care about maximizing profits at this small subsidiary. But… the guy that just got put in charge of this company used to run a larger and more successful competitor, and brought a bunch of his team with him. It’s a structurally good industry where everybody earns very high returns on capital. The business model is like an engineering design company, law firm, or accounting firm, where you build your customer relationships and win bids and you have a stable backlog of years worth of work ahead of you. It’s low margin but there’s no invested capital, so the returns on capital and the free cash flow are very healthy. And the industry itself is growing 6-9% annually and has no cyclicality.
I try to prioritize the actual-investing-stuff over the talking-about-investing-stuff, so please forgive me if there is no family-friendly version of my Citi analysis near future.
For the real hardcore masochists among you, the Citigroup report is attached. At 25 pages, it’s unfortunately one of my longest yet and is a 2 hour read (there are still page breaks and lots of charts and pictures).
Here’s a summary in bullet points, though:
Basically, for decades, Citi built and acquired banks in the US and internationally. Many of these did not pan out. Citi owns some small Polish retail bank, an Argentine one, a Korean one, a Russian one, and so on. None of these is a market leader, and they don’t have local scale. They were earning bad returns on capital.
Citi was also caught with its pants down in the financial crisis, having made many bad decisions over time. (I’ve talked about how a bank slowly accumulates the sum of its lending decisions onto its balance sheet, and there is no instant “undo” button — so when a crisis hits, you eat your cooking; it’s that Buffett quote “It’s not until the tide goes out you see who’s been swimming naked.”). Citi’s CEO famously said during the housing bubble “as long as the music is playing, you’ve got to get up and dance.” Ever since, Citi’s been Humpty Dumpty, trying to put itself back together again.
After making a lot of money for himself but not for the shareholders that actually own the business, the dancing guy was replaced with Michael Corbat. I think he tried. Still, Citi’s returns on capital peaked at only 11% just before COVID, when interest rates were going up and loan losses were low. A bank like Citi should do nearly 20% at the peak, and roughly break even or be profitable at the bottom, averaging 12-16%.
Normally these companies are zombies, stuck in a doom loop of new managements who come in, try some things that don’t quite fix it all, clip some bonuses and send their kids to private school, then retire with an esteemed resume. These stocks always look quantitatively cheap but they are value traps because there is no actual management execution taking place to fix them — there is no catalyst for change, so there’s no way to realize the value of the underlying business’ potential. This is of course why private equity’s buy-fix-sell model has become so big: you buy the whole company, so you control it. If you know a better CEO, you write that one an email and make them an offer, then you toss the existing CEO and get the new one to do the job properly. (Not to say the existing CEO’s a bad person… we just live in a cutthroat world.)
I don’t think Citi is a value trap anymore. I think a “regime change” has taken place, which the market only just began to recognize this year.
Michael Corbat left and was replaced by Jane Fraser a couple years back. I initially did not trust her and CFO Mark Mason — they are Citi lifers and worked for Corbat, so why won’t I get more cut from the same cloth, I thought. At the time, I went and researched and bought Ally and Brookfield instead.
However, undeniable evidence is piling on that Fraser and her team are making fundamental changes to this bank. For example, they are finally, after YEARS, consolidating all the IT systems at the bank, including the CRM systems so that front-office people can make proper referrals to other parts of the bank (some of you in the banks will probably laugh at how basic that is). Fraser sold all the crappy international retail banks, but she kept all the multinational corporate relationships and consolidated them into the big global financial hubs like London, Singapore, Mumbai, Hong Kong, New York, etc. She implemented cultural surveys and stuff for employees, and now executives’ bonuses get docked if people say Citi still has a bulls*** culture. Executives cannot hide and pretend the place is a retirement home. I have tons more examples.
Under the hood, Citi is also a good bank. Structurally speaking, they have some of the best businesses in banking. They are the #2 credit card issuer in the US, which is a 20-30% ROE business for every other one of the 6 competitors in this industry, and there are high barriers to entry. They are big in wealth management, which is also a 20-30% ROE business that doesn’t need much capital, and charges fees to sticky, life-long customers. Investment banking is also a fine, 15% return business. Market-making is not a good business but should still make 9-12%.
Lastly, and unusual for a bank, Citi is also highly international. They have the biggest international corporate treasury management business in the world, which serves 85% of the Fortune 500. Google, Microsoft, and Alibaba use Citi for their treasury, cash management, payments, and liquidity needs. Citi is unmatched and has the biggest cash management payments network in the world, and is twice the size of the next largest international bank. That business at Citi earns >20% ROEs. It takes decades to build a business like that and there are only ~4-5 major players like JPMorgan, Standard Chartered, and HSBC. That’s because it’s a royal pain in the butt to create a bank that crosses many, many borders due to heavy regulation in every country you operate in, the need to build relationships in every country, the fact you have to connect to all the local banks and the payments rails in every country, etc. It’s horrendously complicated, but Citi makes it simple for Alibaba to sell a product in the US or Germany while they pay a supplier in the Philippines and pay payroll in China. Citi will not be supplanted doing this.
Fraser’s getting rid of all the stuff that dragged down returns, while at the same time right-sizing the company’s costs. Fraser is being coached by Warren Buffett behind the scenes.
In a few years, I think Citi will emerge as a ~15% ROE bank, growing with nominal GDP (~5%).
Today, Citi trades at 0.7x tangible book value and if it can earn 15%, will be worth 1.5x tangible book value or more, which means the stock is a 2x. If this doesn’t happen, I think the stock’s worth 5-20% less than what I paid and won’t lose much money.
With the exception of credit card, Citi’s book of business is some of the lowest risk stuff in banking. In wealth management, they make mortgage loans to rich people. In trade finance, they make working capital loans (e.g., to finance inventory while it’s on the container ship) to WalMart’s suppliers and get paid back within months; the loans rank above bonds and other bank loans, and are secured against the company’s inventory or its receivables etc. In credit card, I have views about that industry and think things won’t be that bad in the next recession. Even if things go horribly and I model out some draconian credit card losses, Citi doesn’t even eat into its capital buffer.
This is not some wonderful compounder business with a huge market opportunity in front of them. It’s a very predictable business with a decent position in an industry that has a glacial rate of change. There are very clear first-principles reasons returns should move toward 15%. You also can point to any decent competitor in this business and they make ~15%. And now we have a CEO taking the correct steps to get us there.
I think the idea is a good “base hit” with fantastic risk/reward.
Chris
P.S.: I’ve been asked this. Yes, I write full reports on companies, even when the investment is just for myself. It’s part of my discipline to ensure that I correctly lay out and organize the facts to check that it’s (a) logically consistent, and it (b) looks like I have all the necessary information to make a decision. I’m an intuitive thinker and could think my way through an investment while writing some notes, but I think this method produces better decisions. For example, it prevents “thesis creep”, where you sneakily convince yourself of a new reason to own a business when the old one is no longer true. With everything written and dated, I can look back at why I own something. Thus, on an ongoing basis, I have to prove the thesis is true or that the changes are valid.
We did this with KKR a while back. I pulled out my old report from 2019 and asked “What is still true or not? Based on what has changed, is the thesis working or not? Is it better or worse?” After updating the data and the facts, I doubled the position because the facts said the thesis was working slightly better than expected and yet the stock now traded at a deeper discount to fair value in 2022/2023 than in 2019/2020 (the stock was up ~30-50%, but the business and profit stream had grown +100%.