NEW YORK (
) -- The U.S. Treasury may be getting out of its
stake too soon.
While the stock has
stumbled so far
this week on news that the government has commenced exiting its 7.7 billion share stake in the company, starting with an initial release of 1.5 billion shares, Sandler O'Neill analyst Jeff Harte came away from a recent meeting with Citigroup CFO John Gerspach and Vice Chairman Ned Kelly feeling like the shares still have plenty of room to run.
itigroup has rallied 39% YTD, we believe significant upside remains over the next 12 months, driven by factors that include capital strength, favorable business mix, and still underweight institutional ownership," Harte says in a note issued to clients on Tuesday. He maintains a buy rating on the stock with a 12-month price target of $5.50.
Harte likes the company's plan to continue to build up already strong capital ratios while awaiting further clarity on the regulatory front and for the economy to start creating jobs. Once those two things happen, he sees a "small dividend reinstatement" as likely and believes share buybacks would follow ahead of a "more meaningful" dividend increase.
In the meantime, the driver for share appreciation should be 2010 performance, more specifically "a couple of clean quarters" according to Harte. That would be a switch from last year when it was difficult for Wall Street to get a handle on how Citigroup's businesses were doing amid all the balance sheet restructuring, divestitures, and asset markdowns.
"Management believes the very noisy quarterly results in 2009 masked progress C has made in executing its core strategy," Harte says.
Citigroup is off to a good start in 2010, turning in a
of $4.4 billion for the first quarter, although
CEO Vikram Pandit
made a point of telling investors not to expect a "invariable trend-line upward" in the company's results.
The point that Harte makes about institutional investors not owning enough Citigroup stock should make investors nervous about the downward pressure of the Treasury exiting its stake over the rest of the year feel better. Right now, institutional investors own roughly 40% of Citigroup's outstanding stock compared to 74% for its peer group, according to Harte, who thinks bringing that ratio up to par would "more than offset" the government selling its stake.
He estimates institutional investors need to add an additional 9.8 billion shares for institutional ownership of Citigroup shares to be in line with that of its big bank peers. The purchase of that amount of stock would be enough to account for 6.1% of the average daily volume of Citigroup shares for an entire year, Harte says.
There was also some new information for investors to chew over with regard to the company's ongoing restructuring efforts. Harte says the company's special asset pool is expected to run off over the next few years "as loans are repaid and securities sold" but that the businesses in its Local Consumer Lending basket -- which includes Citi Financial, Citi Mortgage, and student and auto loan operations along with its commercial real estate and retail partner cards holdings -- are likely to take "significantly longer" to divest.
Harte also learned that Citigroup has received a number of reverse inquiries about these assets, and that buying interest has picked up over the last six months, but the company still believes it will take "more time and creativity" to sell these assets because how big they are.
"Businesses like Retail Partner Credit Cards, Citi Financial and Student Lending would all be top 20 bank holding companies on their own, which limits the potential buyer pool," he writes. "Management cited the Primerica IPO and the Smith Barney JV as blueprints for future sales in which significant portions of businesses were sold and C maintained an economic interest."
The meeting with Gerspach and Kelly also yielded insight into what Citigroup's two biggest concerns are these days: the health of consumer credit in North America and legislative/regulatory risks.The executives indicated they would be cautious about consumer credit until the job picture was better, noting that while "we may be at the very beginning of a recovery in job creation, it certainly does not appear robust," according to Harte.
Of the potential for derivatives reform, Harte says Citigroup management couldn't offer an estimate of any revenue impact because "the devil would be in the details" of the final legislation. While a move toward centralized clearing platforms "would likely have a very manageable impact" on Citigroup's revenue, according to Harte, banks having to divest their swaps operations would be a game-changer.
"At the other extreme, forcing banks to exit derivatives trading en masse would significantly change the industry as derivatives touch virtually every aspect of an investment bank's business," Harte writes. "Most cash trading desks use derivatitve(s) to hedge exposures, as do many M&A transactions."
Citigroup shares were down 4.8% to $4.39 in midday action. Volume of 707 million compared to the issue's trailing three-month daily average of 551 million. The session-low of $4.38 represents a dip of more than 13% from a near-term high of $5.07 on April 15. The shares
haven't closed above $5
Written by Michael Baron in New York