According to earnings estimates by Thomson Reuters Citigroup is fairly valued compared to BAC, WFC, and JPM. FY 2010 earnings estimates forward P/E for all 4 banks is between 10.5-12. However, only Citi is assumed to report meager earnings in 2010 (0.27 a share). Pros and cons for July 17, 2Q earnings:
PROS:
1) The major plus for upside earnings is the M2M rule suspension, especially for Citi, without it the bank would incur losses in EPS in the entire FY 2009. However, suspending FAS 157 is a step in the right direction, this is a rule that was not utilized for 70 years, was reinstated in 2007, only to cause a global collapse in 2008.
2) Upward Sloping Treasury Yield Curve : Larry Kudlow pointed out recently that "the upward-sloped yield curve is the real bailout for the banking system." The yield curve is very favorable and provides easy money for all banks. The majority of profits for all big banks in the first quarter of 2009 was a direct result of the upward sloping yield curve and the increasing interest spread. That spread continues to widen in the second quarter.
3) Private equity secondary market offerings: May 2009 was a record month for secondary offerings and Citi was very active in this market.
4) Overseas markets are in pretty good shape and revenues should be rising alongside. In addition, overseas income will get a nice boost due to currency fluctuations.
5) Huge reduction in operating expenses: Pandit iterated that they have reduced expenses by 25%. In the past several months Citi has cut its expenses by almost $4 billion per quarter. If Citi can keep or reduce the last quarter number of $12 bill. expenses, this will further increase bottom line numbers.
6) Credit card losses seem to have stabilized. Citi was the only big bank that had the same default rate on credit cards as April ( as opposed to BAC for example), delinquencies rates fell for the second month in a row (remember that delinquencies are directly correlated with the real credit losses, not the default rates). In addition, Citi has limited exposure to commercial real estate (only 2.5% out of the estimated stress test losses).
7) Nikko Cordial and Smith Barney are still generating revenue for Citigroup in this quarter. They will continue to show good numbers given the fact that the market was bullish in April through mid-May.
8 ) Citi has greatly reduced their risk exposure, this is evident in the 1Q data.
Note: I think there are no savings from dividends this quarter.
CONS:
1) Citi will have considerable credit losses this quarter, and this is the big unknown. The suspension of FAS 157 will provide some cushion to this figure .
2) The major problem is that we do not know what the real earning power for Citi is. Revenuess recieved a huge boost from the "illegal" fixed-income, one-time trading of the AIG CDS, which improved the earnings by at least $2.5B in 1Q(earnings report). All banks took advantage of the easy money offered by the AIG-feds, so we do not know without that one time boost how the earnings will look like. This is directly correlated with Citis sharp fall after 1Q earnings ($4.40 down to $2.80), investors needed time to read the data and realize that the absolutely surprising profit came from one-time AIG CDS.
3) Citi is loosing talent due to the government harsh pay regulations, in addition they have reduced enormously their risk exposure which reduces any risky investments that can yield large profits. We might not see the same performance in these segments: Institutional Clients Group and Wealth Management, and these two are absolutely critical for sustained increase in the net revenue.
Summary: The only way Citi can show improved earnings is by cutting expenses, obviously their revenues are not going to be the major moving factor due to the cuts, lay offs, brain drain, selling assets, etc...however the emerging markets can help a bit to the net revenue. But again, if Citi can keep or even lower the last quarter number of $12 bill. expenses earnings will come in above analys estimates. Analyst estimates for FY 2010 earnings (revenues) are based exactly on the adverse scenario from the stress test. If the credit losses are flat or even less than the previous quarter then this will lead to a huge boost, since the analysts will not extrapolate with the worst-case scenario anymore. On the other hand, the first stage of the conversion ends July 30 - just 2 weeks after the earnings release. The end of the arbitrage is important. The $58 billion preferred exchange offer includes $25 billion of government preferred, $12.5 billion of private preferred, $15 billion of public preferred and $5.5 billion of Citi trust preferred. It will be interesting to see after these funds are released what the hedge funds next move is. Will they leave the C trade? This will be important for the short term trend, if the earnings are good (show some upside surprise), they might invest in C , while if they are terrible or in-line with estimates then they will short and we can go back to 2.00-3.00 range. Citi should show positive earnings, not mind-blowing, but still something around $1.5-2B this 2Q. If we see earnings of that order, PPS will trade in the 4-4.50 range in August-September. |
