Even as the market rally was building a solid head of steam in the years following the Great Recession of 2008, two key sectors remained sharply out of favor. Both insurance stocks and banking stocks traded far below book value, which created a rare opening for deep value investors.
The price-to-book disconnect was especially profound with banking giant Citigroup (NYSE: C). As I noted nearly two years ago, shares had traded down to just 53% of book value by the summer of 2011, and with the passage of time, investors seized on that gap, eventually pushing shares up to $55.
Yet a recent pullback has widened the price-book gap again:
To be sure, Citigroup has aggressively pursued emerging-markets exposure while most other U.S. banks have avoided expanding into those markets. That should really pay off over the longer term, as emerging markets still represent the most dynamic long-term growth opportunities.
But is Citi's push into emerging markets going to create a drag in the near term? Not likely, according to Oppenheimer analyst Chris Kotowski: "Citi's 'emerging markets' exposure is generally not in the current hot spots like Argentina and Turkey, but skewed toward fairly well developed economies like Mexico, Korea, Australia, Singapore and Hong Kong." Fully one-third of Mexico's emerging-markets exposure is derived from Mexico, which is quite stable, and those other economies mentioned account for another 20%, according to Kotowski.
As these concerns recede (especially when Citi delivers first-quarter results in April that are likely to reflect minimal impact from exposure to emerging markets), investors will likely again focus on what has become a very healthy bank.
For example, the dollar value of loans being held on the books as "doubtful accounts" has dropped for 13 straight quarters. Kotowski thinks "that the ongoing businesses in Citicorp easily have $5.50-6.00 per share of earnings power; probably more if and when capital markets revert to a more normal state of affairs." Shares, now trading below $50, sharply discount that view, and explain why he thinks shares are headed towards $63 (representing 34% upside).
That target price is likely too conservative, for one simple reason: Tangible book value is headed toward the $70 mark, according to Merrill Lynch. If you chose to buy this stock today and planned to hold it until the end of 2016, you could be looking at a 53% gain, assuming shares rise up to tangible book value by then.
Merrill Lynch analysts figure C will rise to $65 in the next 12 months: "We believe (Citigroup) is one of the more misunderstood banks in that investors view outsized risk in its international operations, but overlook the company's EPS leverage to a U.S. housing recovery. Moreover with share buybacks returning in '13, investors should have more confidence in the capital return ability at C. Our (price objective) also implies one of the highest potential returns out of our universe," they recently wrote in a note to clients.
Risks to Consider: Those rising book value forecasts are based on expectations of a firming U.S. economy and housing market. If the U.S. economy cools off later this year, then this and other bank stocks are unlikely to rally.
Action to Take --> Citigroup has been in the midst of a five-year overhaul of its operations, and it's far healthier than it was even a couple of years ago. By the time the emerging-markets concerns abate -- and when the U.S. housing market begins to rumble back to life -- look for shares of Citigroup to again march steadily higher.