I have written frequently about why I think the megabank Citigroup (C 0.10%) at the past few months' levels. Over the long term, I expect shares to rise substantially as the bank executes its refresh strategy and corrects its regulatory issues. While I don't know exactly when that will happen, I can say with a certain degree of confidence that when Citigroup reports its third-quarter earnings, there should be even more reason for the stock to move up, particularly in the long term. Here's why.
Citigroup's price to tangible book value
Most banks are valued in relation to their tangible book value (TBV), which is what a company would be worth if it were immediately liquidated. After years of industry-lagging returns and longstanding regulatory issues, Citigroup's stock and valuation have struggled. After its stock fell into the high $30s early in the pandemic last year, the stock battled back, and in recent days it's traded around $73 per share. But even at this level, Citigroup trades at just 94% of TBV. That's cheap compared to most of Citigroup's peers and the industry in general.
However, after Citigroup reports earnings, I think there will be even more reason for investors to purchase the stock, because I expect TBV per share to grow. When TBV grows, a bank's stock price tends to follow, because if you believe a bank is worth a certain valuation, the stock price would have to increase as well to stay in line with that valuation. I expect Citigroup will show some pretty solid TBV growth next quarter because the bank has been repurchasing shares, and when banks do this while trading below TBV, the math works out so they end up growing TBV per share.
We know Citigroup is repurchasing shares because management told us as much on past earnings calls. In the first half of 2021, Citigroup returned roughly $7 billion to shareholders through dividends and stock repurchases. But at the time, banks were also subject to limits set by the Federal Reserve on how much capital they could return to shareholders. Citigroup CEO Jane Fraser noted $7 billion was the maximum the bank could return under the Fed's rules. Those restrictions were lifted at the end of the second quarter, leading me to believe that Citigroup likely repurchased more shares in Q3 than it did in either of the first two quarters of the year.
Tangible book value is likely to grow
The opportunity to repurchase shares for less than tangible book value is usually a gift to banks -- especially for a well-capitalized bank with good earnings power, like Citigroup. That's why most expect management to take advantage. Wells Fargo analyst Mike Mayo said on Citigroup's second-quarter earnings call, "I mean, you're not blind to the fact that your tangible book value is $78, and your stock price is $68. So you should probably be selling the -- your desk chairs and your silverware and anything you can to buy back your stock, I would think."
In the first and second quarters of this year, Citigroup repurchased $1.6 billion and $3 billion worth of shares, respectively. Assuming Citigroup repurchases more than it did in the second quarter -- considering it traded below TBV for the entire quarter and there were no Fed restrictions in place -- I would expect TBV to potentially grow more than it did in the first two quarters. TBV per share grew 2.5% in Q1 and then 3.1% in Q2, so I think it's very reasonable to assume TBV per share grows at least 3.5% or 4%. Another 4% added to Citigroup's TBV per share takes it to almost $81. Then all of a sudden, a 94% TBV per share valuation would send Citigroup stock to more than $76 per share.
Now, there is no guarantee that life will work like this, as it rarely does. But over the long term, a higher TBV per share is great for Citigroup -- especially if it can execute its strategy, which looks promising.
Think about valuation
My point in telling you all of this is that right now it's reasonable to believe that Citigroup's TBV per share will grow simply because the bank likely repurchased more stock in Q3 than in any other quarter this year. When this happens, Citigroup's valuation will look lower than it is now, which could be the case in some investors' eyes. But as the bank's refresh plan becomes more clear, as it gets more profitable, and as it's hopefully able to correct longstanding regulatory issues, Citigroup's stock is likely to follow TBV upward. That's why I do not believe the stock will be this cheap for long.