Summer 2016 is fast turning into the Summer of Brexit for financial stocks.
It's been two weeks since Britain's vote to exit the EU rocked stock markets around the globe. And while markets seemed to shake off their malaise and settle down pretty quickly, that may have only been a pause before the aftershocks.
This morning, we felt one of those follow-on trembles of fear, when analysts at Wells Fargo (NYSE:WFC) announced they have decided to downgrade Citigroup (NYSE:C) stock -- because they're finally worried about the consequences of a Brexit that happened two weeks ago. The downgrade takes Citigroup from an outperform rating to market perform, and shaves $5 off of Wells' previous $50-to-$52 price target on the stock.
Here are three things you need to know about it.
Thing No. 1: It's all about the Brexit
Wells Fargo's decision to downgrade Citigroup two weeks after Brexit happened may seem like the analyst was slow out of gate. But as TheFly.com explained in a write-up this morning, Wells is actually expanding on its initial thoughts about Brexit.
Initially, investors worried that Brexit would slow growth in Britain and Europe. But what Wells is saying that growth rates among emerging economies could also take a hit.
Why this is important to Citi in particular, as contrasted with rival megabankers in America's big Four -- Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), and Wells Fargo itself -- is because the international banking market is the "key facet and differentiator of the Citi story," and probably the single most important thing that differentiates the bank from its competitors.
Thing No. 2: Is that true?
That's a very good point. If you compare the four major too-big-to-fail banks, they all look pretty similar in some respects. Valuation-wise, for example, these banks trade in a pretty tight range of from 8.2 times trailing earnings (Citigroup) up through 11.5 times earnings for Wells Fargo itself. Growth-wise, all four banks are pegged by most analysts for single-digit earnings growth over the next five years -- again, with Citi's prospects being the weakest at 4.1% projected, and Wells the strongest at 9.4%.
What sets Citi apart, perhaps, is that of the four banks named, only Citigroup boasts a record of positive sales growth over the past five years.
Thing No. 3: Where the growth is at
How has Citigroup been growing, when its peers have been shrinking? International may be the area to look at here, as Wells is doing. According to data from S&P Global Market Intelligence, Wells Fargo gets 100% of its revenue from banking operations in the United States. As you might guess from the name, Bank of America gets 87% of its revenue from North America, and JPMorgan Chase does 76% of its business here. Citigroup, however, derives only 43% of its revenue from North America, meaning that most of its business comes from somewhere else.
Specifically, 13% of Citi's revenue comes from Europe, the Middle East and Africa -- a region that includes the epicenter of Brexit, and provides one reason to worry about the stock. Meanwhile, fully 33% of Citi's revenue comes from Latin America and Asia -- both emerging markets, and the focus of Wells Fargo's worries today. (A further 11% of Citi's revenue is described as coming from "corporate/other," which while ambiguous, also presumably refers to emerging markets.)
And one more thing: Valuation
If Citi's international business takes a hit post-Brexit, Wells Fargo could be right that the stock is one to be avoided -- and to be perfectly honest, I'm not sure Citigroup stock was looking all that attractive to begin with. Valued at just 8.2 times earnings, Citi may be the cheapest of the too-big-to-fail banks. But the stock's projected 4% earnings growth rate is nothing to write home about, and its measly 0.5% dividend yield doesn't do much to make it more attractive.
Personally, if I was looking to invest in a big bank, I think I'd be more inclined to invest in Wells Fargo instead: At an 11.5 P/E ratio, a 9.4% growth rate, and a generous 3.2% dividend yield, it actually looks to me like the best bargain of the bunch.