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Citigroup Shares Have 35% Upside: BAC Merrill

NEW YORK (TheStreet) -- Shares of Citigroup (C - Get Report) are down 8% this year through Thursday's close, setting up a golden opportunity for investors, according to Bank of America Merrill Lynch analyst Erika Najarian.

Citigroup's shares closed at $48.25 Thursday, trading for 0.9 times their reported Dec. 31 tangible book value of $55.38, and for 8.4 times the consensus 2015 earnings estimate of $5.76 a share, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $5.01.

That's among the cheapest forward price-to-earnings ratios for all U.S. bank stocks, and Citigroup is the only large-cap bank trading below tangible book value.

The nation's largest banks trade at significant discounts to regional banks and to the S&P 500 ^GSPC, and there is good reason for this, because the big banks face much greater regulatory scrutiny, have higher capital requirements, and in many cases are continuing to clean up legacy messes left over from U.S. the housing crisis.

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But Citi is the cheapest in part because of its unique international flavor. During 2013, 56% of the company's adjusted revenue and 62% of its adjusted net income came from outside North America.

This has led to some painful recent action during broad market declines springing from economic reports showing slowing manufacturing growth in the United States and China, as well as the concern over capital flight from emerging market economies.

In a note to clients on Friday, Najarian reiterated her "buy" rating for Citigroup, with a $65 price objective, writing in a note to clients, "we believe the pullback in the stock has created an especially compelling entry point for investors."

In addition to the emerging markets concern, Najarian believes Citi's relatively weak fourth-quarter performance "undermined the market's confidence in C's ability to achieve its '15 targets," which include a return on tangible common equity (ROTCE) of 10% and a return on average assets (ROA) ranging from 0.90% to 1.10%.

"We believe bank stocks deserve to trade below tangible book if: 1) balance sheet risk threatens TBV; or 2) it can't earn its cost of capital. We think C will disprove these worries over the next 12 months," Najarian wrote.

Her view stands in sharp contrast to Rafferty Capital Markets analyst Richard Bove, who on Jan. 29 cut his rating for Citigroup all the way to a "sell" from a "buy," while lowering his price target for the shares to $44.50 from $57.00. Bove in a client note wrote that the basis for his previous "buy" recommendation was the discount to book value. "I no longer believe that Citigroup's book value can be trusted," he wrote.

Bove last week went on to write, "The issues arising in a number of foreign nations suggest that loan quality at Citigroup may erode. The bank was the only one I follow that showed weaker loan quality in the fourth quarter and the problems here may accelerate."

"When a currency problem arises in multiple countries worldwide that forces dramatic changes in interest rates and banks suffer. Business in those countries weakens. Citigroup is the only U.S. based bank that is vulnerable to those trends," Bove added.

Najarian believes investors' concern over Citi's emerging-markets risk is "overdone."

"Based on our analysis, if Mexico, Korea, Hong Kong, and India (C's largest countries of concentration where trailing GDP has declined) post peak losses all at once - an unlikely scenario - we project a 7% hit to EPS while TBV would still grow 11% [year-over-year]."

Bank of America Merrill Lynch estimates Citigroup will earn $5.02 a share this year, with EPS growing to $5.73 during 2015. Both of those figures are close to the consensus estimates. But Najarian is out in front with a 2016 EPS estimate of $6.49, compared to the consensus EPS estimate of $6.24.

A big driver for Citigroup's EPS growth is expected to be an increased deployment of excess capital, mainly through share buybacks, as the continued wind-down of the noncore Citi Holdings subsidiaries frees up capital and helps the company recapture deferred tax asset valuation allowances (DTA).

Following the last annual round of Federal Reserve stress tests, Citigroup in March of last year announced it had received regulatory approval to buy back up to $1.4 billion in common shares from the second quarter of 2013 through the first quarter of 2014. Najarian didn't predict how much capital deployment Citi would announce after this year's stress tests are completed, but wrote, "While we don't expect C to return as much absolute capital as large-cap peers this year, we still think the March stress test results will be a positive catalyst."

Evercore Partners analyst Andrew Marquardt in a client note on Thursday estimated Citigroup would receive Fed approval for $3.443 billion common-stock buybacks from the second quarter of 2014 through the first quarter of 2015.

Citigroup's shares rose 2.5% on Thursday, when most bank stocks were lifted, following an upbeat weekly unemployment claims report from the Department of Labor. Citi's shares in the first minutes of trading on Friday were up 1.% to $49.15, after the Labor Department said the unemployment rate for January declined to 6.6% from 6.7% in December, and that the U.S. labor participation rate increased during January. That last development is very important, following the significant labor-force contraction of 2013.

This table shows the performance of Citigroup's stock against the KBW Bank Index (I:BKX) and the S&P 500 (^GSPC):

C Chart data by YCharts

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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