Citi Still Offers Great Value, Despite Government and Legal Issues

NEW YORK (TheStreet) -- To say Citigroup (C) has an image problem would be a gross understatement.

Investors paid dearly when Citi's capital plans (more on the plan below) were shot down by the Federal government, a move that blocked it from paying a juicy dividend. When the company reports Monday, it must convince investors that it is financially sound and that the Fed will be on its side the next time around. Despite all this, it is an attractive buy. The stock closed Friday at $47, up 10  cents.

With the Citi stock closing Thursday at $46.90, shares are down 10% on the year to date, trailing the banking sector's 5.41% gain.

Shares have shown no signs of life as the bank deals with allegations of having sold questionable mortgage loans to consumers. Some believe Citi's alleged shady loan practices lead to the financial crisis from which our economy is still recovering.

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According to reports, a proposed $7 billion settlement with the U.S. Justice Department is expected as early as next week. This is $3 billion more than the $4 billion Citi expected to pay.

This is no cause for disappointment, however.

Citi hasn't been alone in this. JPMorgan Chase (JPM), which is often considered better-managed, has dealt with similar issues. JPMorgan eventually settled its own charges for $12 billion, 71% more than what Citi is on the hook for.

What I think is more important, at this point, is for investors to focus on how management plans to move Citi beyond this issue. To what extent can management maintain the bank's core banking operation? That should be a top priority. For that to happen, Citi must return to growing its mortgage business and refocus on its credit-cost reduction, among other needs.

Next, it needs to regain the trust of the Federal Reserve, which, earlier this year, rejected management's $6.4 billion share buyback proposal. The bank, which failed its annual stress test, was considered "fiscally unfit" to return such a large amount to shareholders. The stock still has not recovered its 6% decline since that announcement.

Having been granted a 6-month extension, Citi now has until January 2015 to demonstrate to the Federal Reserve that it has an executable capital plan -- one that comes with not as much risk. But that, too, must be understood. Keep in mind, money is not made without risk.

Citi is the nation's fourth-largest bank by assets. Plus it has the largest global reach among the major banks -- topping Wells Fargo (WFC), Bank of America (BAC) and JPMorgan.

This global power also means that Citi is highly levered to the global economy. Not to mention, Citi still has a strong dependency on the housing recovery. Depending on who you ask, both the global economy and U.S. housing are on the uptrend.

So why isn't the stock reacting to these positives? This is what management must address when the bank reports earnings on Monday.

After being denied a divined increase and $6.4 billion in buybacks, investors will want assurances that their patience will be rewarded.

To that end, Citi's operational numbers will be secondary. Despite the stock's decline, Citi has strung together -- in my opinion -- solid quarterly performances. By "solid" I mean revenue and earnings results that have not swayed from numbers posted by Wells Fargo and JPMorgan.

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What's more, given the weak interest rate environment, not to mention the struggles cited above, not much is expected this quarter anyway. Investors should focus more intently on what management says about the next 6 to 12 months. And to the extent management can convince that this mode of perpetual restructuring is over.

With Citi's ongoing expense-controls and shedding its poor-performing assets, the bank does not carry the same investment risk as it did two years ago. Assuming these initiatives remain on track, they should offset any legal expenses and costs related to Citi's regulatory compliance.

At around $46 per share, these shares are a buy. And when you consider that Citi is trading at almost half the P/E of Bank of America, there is an assumption that Citi will not grow at all. Investors have already paid once for Citi's mistake, missing out on a good buying opportunity would be another.

At the time of publication, the author did not hold any stock in the companies mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates CITIGROUP INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate CITIGROUP INC (C) a BUY. This is driven by some important positives, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its attractive valuation levels, expanding profit margins, increase in net income and notable return on equity. We feel these strengths outweigh the fact that the company shows weak operating cash flow."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • CITIGROUP INC reported flat earnings per share in the most recent quarter. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, CITIGROUP INC increased its bottom line by earning $4.25 versus $2.46 in the prior year. This year, the market expects an improvement in earnings ($4.60 versus $4.25).
  • 38.78% is the gross profit margin for CITIGROUP INC which we consider to be strong. It has increased from the same quarter the previous year. Despite the strong results of the gross profit margin, C's net profit margin of 16.62% significantly trails the industry average.
  • The net income growth from the same quarter one year ago has exceeded that of the Commercial Banks industry average, but is less than that of the S&P 500. The net income increased by 3.5% when compared to the same quarter one year prior, going from $3,808.00 million to $3,943.00 million.
  • C, with its decline in revenue, slightly underperformed the industry average of 2.6%. Since the same quarter one year prior, revenues slightly dropped by 3.5%. The declining revenue appears to have seeped down to the company's bottom line, decreasing earnings per share.

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