Introduction
- Prior to the financial crisis, C was the largest financial services company in the world and at one point, the 4th largest company in the world by market cap.
- By 2008, C was insolvent due to massive losses and asset impairments, but they were bailed out by the U.S. government.
- C has been on the road to recovery ever since and in the last decade has become a very different institution than it was before.
- Ample capital ratios, Fed oversight, and its survival of the pandemic demonstrate that C has come a long way.
- While C is still not on par with the other banks in terms of quality, management has emphasized that they are aware of the challenges the bank faces. The new CEO appears to be in-tune with what shareholders want to see and willing to make tough choices.
- C’s valuation makes them just too difficult to ignore, especially with the potential upside from improving ROTCE and the strong economic growth that is likely coming.
Simplification
- Since the financial crisis C has been working to improve their returns on equity by disposing of non-core assets.
- In the outgoing CEO, Michael Corbat’s 2020 letter to shareholders he states that since he took the helm in 2012, “Our financial performance improved steadily as we became a simpler, smaller, safer and stronger institution.”
- This simplification process has hampered growth but improved returns.
- The new CEO seems intent on maintaining the strategy of simplification. She has been very much in conversation with C’s investors who have made it clear the priority is getting returns in line with other banks.
- Her strategy is to direct capital and resources to areas where C has competitive advantages and can be a leader, exit areas where they can not and return excess capital to shareholders.
- She seems committed to making the necessary tough calls, as she did on the Q1 earnings call when she announced that C’s retail banking segment would be exiting all but four international markets.
- Management believes that long-term they can reach peer-level ROTCE, which is about 15%.
- In 2013, C’s first year after the crisis without large impairment and credit loss reserving, ROTCE was 8.2%. By 2019 it has risen to 12.1%, an improvement of more than 0.5% per year. 2020 ROTCE would have likely been around 12%, or even higher, were it not for the pandemic.
Valuation
- C is very cheap, cheaper even than struggling Wells Fargo, trading at just 8.9x 2019 earnings.
- With 2020 revenues flat YoY the main driver of lower earnings in 2020 was reserving, which was not unique to C. Other expenses were slightly elevated due to C’s efforts to improve their technology and internal controls, according to management.
- C also trades at about 0.94x tangible book value. For comparison, JPM trades at 2.31x TBV, BAC trades at 1.94x and WFC at 1.35x.
- With JPM trading at 14.3x 2019 earnings and C trading at 8.9x, implying a difference in growth rates of more than 4% in perpetuity, C is basically priced for no growth
- I consider this outcome extremely unlikely given that asset growth in the banking industry should be highly correlated with growth in the money supply
- Coupled with potentially improving ROTCE going forward and a likely strong economy, it seems probable that C will return to growth soon.
- Also with their focus on simplification they may continue to return more than 100% of their cash flow to shareholders.
- Finding a business trading at less than 9x earnings and less than TBV is uncommon in this market. The fact that this is one of the largest companies in America makes it that much more attractive.
Safety
- C is a much different organization than it was prior to the financial crisis.
- Currently their Tier 1 capital ratio is 11.7%, in line with WFC and BAC at 11.8% and comfortably above the regulatory minimum of 10%.
- The banking industry is also now subject to significant oversight, a prime example being the Fed’s annual stress tests.
- The following table shows losses of each of the big banks under the Fed’s “severely adverse scenario”:
- These results show C with much less losses than competitors.
- The Fed also saw no problem with C distributing more than 100% of their earnings in 2019.
- Resuming buybacks should be a boost to the stock.
Conclusion
- C is undervalued, compared both with the market and its peers.
- The stock is priced for no growth and poor returns, if either of these factors improve the stock should rise. A price below TBV provides downside protection.
- The bank is very stable, well positioned to withstand either a recessionary or inflationary environment.
- Business performance has been improving since the financial crisis and management seems very focused on continuing this trend.
- At December 31st, 2020 C was Michael Burry’s largest position.