A few weeks ago, Citigroup (NYSE:C) reported earnings that disappointed investors. Though earnings per share did indeed miss expectations, long-term shareholders shouldn't be alarmed. To the contrary, Citigroup's current share price creates quite a buying opportunity.
The banking sector is cheap right now
The banking sector is trading at a very inexpensive price relative to historical levels. Bank of America's (NYSE:BAC)stock, for example, is trading for about 1.1 times its tangible book value, which pales in comparison to what it fetched before the mortgage bubble.
While a return of Bank of America's valuation to pre-crisis levels is probably unrealistic, I think an intermediate-term valuation of closer to two times TBV is a reasonable expectation. It is also worth noting that the tangible book value of the company has been consistently improving in recent years.
Tangible book value represents the net shareholder's equity in a business, excluding intangible items such as goodwill. Bank of America's TBV has improved from a low of $7.14 per share in 2008 to the current level of more than $13.
It's not only the big banks that trade at a discount right now. Regional banks, such as SunTrust (NYSE:STI), can be an excellent way to take advantage of the low valuations while lessening your exposure to the continuing fallout from the mortgage crisis.
SunTrust is not quite as inexpensive at Bank of America at 1.4 times TBV, but I see SunTrust as a less risky investment because of its more limited exposure to the lingering effects of the financial crisis. SunTrust's valuation peaked at about 3.3 times TBV in 2007 and its historical average valuation is around 2.5 times TBV. That average multiple implies a potential 79% upside over the current share price.
That brings us to Citigroup, which certainly has its share of problems. However, the problems facing the company are all temporary and more than priced into its shares.
Current issues plaguing Citigroup
Citigroup's lending business took a significant hit during the summer due to the spike in interest rates to multiyear highs. This caused a slowdown in mortgages and home refinances. In fact, the interest rate spike had such an adverse effect that Citigroup's mortgage lending declined by 20% from the same quarter last year.
The interest rate spike also caused bond trading to slow significantly, and the company's bond trading revenue was down 26% last year. Virtually all major financial institutions took a hit because of the current environment, but it certainly played a big role in Citigroup's earnings miss.
Citigroup's progress has been fantastic
Citigroup has come a long way since the financial crisis. It now has a much stronger capital position, and its balance sheet has continuously improved over the past four years. Just from the previous quarter, Citigroup's Basel III Tier 1 common ratio improved by 40 basis points to 10.4%, and the company's tangible book value improved by about 3% to $54.52. That means that Citigroup is trading at a discount to its TBV.
The credit quality of Citigroup's loan portfolio has also improved significantly, as is apparent in the bank's loan-loss allowance declining from $25.9 billion last quarter to $20.6 billion this quarter.
Where could we go from here?
CEO Michael Corbat has set ambitious profitability targets for Citigroup. The company's recent numbers indicate a return on assets of 0.69%, which is much improved over last year's, but still far below what is considered good profitability in the banking sector. Corbat is aiming for a 0.9% to 1.1% return on assets by 2015.
That would translate to annual earnings in the $6.20 to $7.57 per share range based on the current assets and number of outstanding shares. If we valued the company on a price-to-earnings basis and used the company's current multiple of 10.9 times forward earnings, this would give us a price range of $67.58 to $82.51 by 2015. Based on historic valuations, tangible book value implies even more upside. So, while the company's latest results may have not quite measured up to what analysts were hoping for, the rest of us have been given an extension on Citigroup's bargain price.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Bank of America. It owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.