Friday, March 28, 2014

"The Banks ask for permission.  And the Government says..."

Citigroup ("C" $47.50 per share)

As a result of Dodd-Frank Legislation, our primary bank regulator--the Federal Reserve-- now requires the largest 30 US banks submit to a severe "hypothetical" stress test of their financial condition as a way to measure and determine IF a bank may be overly exposed to risk.  The hurdle relates to their tier one common equity ratio staying above a 5 percent level post-stress.  The 2014 test results were released last week and all but one (Zions Bank) passed.  And while this is good news, the markets yawned.

Now this week:

Step two in the "Dodd-Frank" Regulation (love the name) requires that these same banks submit their annual "capital plans" to the Federal Reserve for comment and approval.   Results were released last night.  And...? Not so good.  Twenty-five of the thirty banks received approval on their submissions but five did not.  The markets tensed, analysts cut ratings and CNBC was able to fill air time on Thursday. 

Let me draw from the Fed's press released dated 3/26/14:

"Based on qualitative concerns, the Federal Reserve objected to the capital plans of Citigroup Inc.; HSBC North America Holdings Inc.; RBS Citizens Financial Group, Inc.; and Santander Holdings USA, Inc. The Federal Reserve objected to the capital plan of Zions Bancorporation because the firm did not meet the minimum, post-stress tier-1 common ratio of 5 percent."

As an owner of Citigroup stock, I was anticipating a pass on this step but was wrong.  And clearly, Citi Management was looking for a pass too. In fact, you can sense surprise by their response alone.  It was weak and went along the lines of "we're being held to the higher standards due to past circumstances."  Management went on to mention their capital plan included substantial share repurchases and an increase in the dividend rate from a penny to five cents per quarter.  This dividend move was one of the core reasons for our move into "C" stock.  News like yesterday was a surprise and is reason to rethink our commitment. 

Perhaps what is most frustrating about this week's news is the fact that their capital plan submission failed to receive Fed permission not because of their current capital position and balance sheet strength, but because the regulators had qualitative concerns.  In other words, Citigroup is having trouble passing the Government's subjective judgments.  A recent operating loss of $500 million in Mexico (fraud) may have been the issue.  My thought: the qualitative issues are likely centered on the company's international segment and is in response to this event. 

But I think I am right about two things on Citigroup:

One, their balance sheet condition is strong today--maybe the strongest in decades.  Two, the valuation on the company is too cheap and investors are demanding much compensation for this risk.  In my eyes, this makes Citi an attractive play at this time. 

Some comparatives (3/27/14)

C : Citigroup Inc NYSE
S&P United States BMI Financials
S&P 500 Index
Price/Forecasted Earnings (FYF)10.4313.4217.20
Price/Tangible Book (MRQ)0.891.042.77
Price/Cash Flow9.106.0814.71
Return on Equity (%)6.746.5713.07
Dividend Yield (%)0.081.911.90

 (source:  Schwab, Thompson Reuters, SP Capital IQ)

For US Banks, there is good news to be found in yesterday's press release from the Fed:

"U.S. firms have substantially increased their capital since the first set of government stress tests in 2009. The aggregate tier 1 common equity ratio, which compares high-quality capital to risk-weighted assets, of the 30 bank holding companies in the 2014 CCAR has more than doubled from 5.5 percent in the first quarter of 2009 to 11.6 percent in the fourth quarter of 2013, reflecting an increase in tier 1 common equity of more than $511 billion to $971 billion during the same period.     That trend is expected to continue."


Citigroup needs to mend their relationship with the regulators.  Citigroup will work through the qualitative issues that surfaced in the rejection slip.  Citigroup will likely meet the consensus EPS target of $4.83 per share this year.  Citigroup will continue to build up its capital position. Citigroup will likely be pressured to reorganize.  And once they pass their next capital plan, Citigroup's dividend payout to investors will begin a path to normalization.

I remain a long term buyer. 

Friday, February 28, 2014

What about Citi's Dividend?

Citigroup, Inc.  (“C” $49)

Citigroup is a familiar company to most people.  New York based, long history, global footprint.  However, it’s suffered mightily over the last five years when it slid into the penalty box during the financial storm of 2008.  To an extent, Citigroup remains there today and the signs of disfavor are easy to point out: a PE valuation below 10x (FYF), a substantial discount to tangible book value, and a persistent level of attention from bank regulators. 

To the point, we see some light on the horizon and think that investors should recognize both the changes that have been made and will be made.  To start with, leadership has improved.  We like a Board that is chaired by Michael O’Neill and recognize him as a banker with decades of experience and a record of success.  Further, we are confident that Michael Corbat will guide the company through the structural changes that will bring better focus and better financial results. 

Speaking about change, one should be asking the question, “Will Citi’s dividend jump soon?”  We think yes and consider “C” as an interesting play for dividend growth investors.  Some thoughts:

·         Current annual dividend of $0.04

·         Current dividend yield of 0.08%

·         Current payout ratio (TTM) of 0.91%

·         Dividend Coverage ratio (TTM) of 9,975%

The comparatives are interesting as well.  A quick review illustrates the fact that Citigroup has been held back due to its need to shore up its capital position and has lagged peers in a big, big way:

Dividends Paid (TTM)
 $       0.03
 $       0.04
 $       1.44
 $       1.15
Annual Yield %
Payout Ratio (TTM) %
Coverage Ratio (TTM)



The company has been using recent earnings for share repurchases and, given their discount to book, this seems logical.  Moreover, all banks are obligated to seek approval from the Federal Reserve prior to any share repurchases and dividend payments (Federal Reserve’s Comprehensive Capital Analysis and Review Plan) and the bank has been moving their Basil III capital position close to the 10 percent target.  Again, we keep asking the question, “Will Citigroup’s dividend jump soon?”  Others are raising this question and have taken both sides: the WSJ and Motley Fool for example. (1) (2) 

Our bet is that they move it up this year and for several years to come.  We estimate a future dividend payout ratio that is closer to 30% and, based on $4.98 estimate for 2014, this would translate to an annual dividend payment of $1.50 or better.  As such, we bought our first shares this week.   

(1)   WSJ "Heard on the Street"  David Reilly  January 6, 2014
(2)  Patrick Morris  November 29. 2013

Wednesday, February 19, 2014

Taking Aim on Target (TGT: $56)

“Current Valuation should attract dividend growth investors”
The “data breach” story broke in January causing both Target shoppers and stockholders to react.  One thing is certain:  the full story on what happened and who has been harmed is not written.  Current estimates on the cost of Target data breach for banks has eclipsed $200 million (AP 2/18/14).  Worse, conventional wisdom suggests that almost one third of all Americans were impacted.
Target’s CEO has attacked the problem head-on and has committed all resources necessary to fix the weaknesses in their data systems.  He has asked for extensive disclosure and has approached the crisis transparently.  Some are critical of their early responses.  However, we are staking out a position that IT Security at Target is much improved and sense that shoppers are slowly returning to the stores.  Investors should reconsider as well.  And from our vantage, there are three reasons why:
·         Valuation metrics

·         Dividend Character

·         Fundamentals

TGT shares have fallen from $64 to a $56 price level today (-12.5% YTD).  Key valuation metrics read like this (source:  Schwab)--

·         Forward Price Earnings ratio of 17.6 times based on a $3.10 estimate for 2014.  This compares to a forward PE of 18.5 times for the SP500 (“market’).

·         Price/Tangible Book (MRQ) of 2.21 versus 2.75 for the market.

·         Price/Cash Flow of 6.9 versus 14.6 for the market.

·         Price/Sales of 0.48 compared to 0.51 for Walmart and 1.57 for TJX
TGT Management has demonstrated a strong commitment to paying and growing the stock’s dividend.  For us, this dividend growth character is important and will carry into the future.  To give you a sense of things, the annual dividend rate per share and other statistics have tracked as follows (source: Schwab)--
2006                $0.44              
2007                $0.52               18% increase YOY
2008                $0.60               15%
2009                $0.66               10%
2010                $0.84               27%
2011                $1.10               31%
2012                $1.32               20%
2013                $1.58               20%

2014                $1.86               18% Walrus estimate

Payout ratio (TTM)                            43.4%
Dividend Coverage Ratio (TTM)       230.3%
5 year growth rate                            27.2%
10 year growth rate                          19.1%

Fundamentally, the market has discounted recent events and 2014 consensus projections have incorporated the potential impact to both revenues and earnings this year.  Importantly, this breach event was not isolated and the TGT response is not exclusive.  Other CEO’s have followed up with their own preventative measures and the retail sector is experiencing a moment reminiscent of the “Y2K” period.
The company should generated profits near the consensus view of $3 plus this year.  Their long term goal of $8 per share EPS is still the target (as they say).  Whether they hit this target or only come close, investors should be the ultimate winners.  We have stepped up and bought the stock yesterday and will add more on any price weakness.