Economic Overview
GDP
The U.S. economy is continuing to expand, albeit at a slower pace than expected. Initial reports
gauged GDP growth at 3.5% but have since been revised downward to 3%1. Aside from energy
prices, several other factors have been cited for the lower GDP growth: The trade deficit has
widened, households have lost the stimulus of the tax cuts, there has been a reduction in
mortgage equity withdrawal in response to rising interest rates, and productivity growth is
slowing. Slowing productivity growth will harm profit margins and potentially increase inflation.
Current Account
The U.S. current account deficit has widened and has hampered growth by hurting U.S.
exporters’ sales and siphoning U.S. consumer demand overseas. That deficit must be financed
by selling dollar denominated assets to foreigners. This will push the dollar down. U.S. exports
will become cheaper to foreigners and U.S. imports will become more expensive to Americans,
thus reducing the trade deficit. A drop in the dollar would encourage the Fed to raise interest
rates because demand from foreigners would put inflationary pressures on import prices.
Interest Rates & Oil Prices and the Dollar
Fed officials cite energy prices as the main risk to the economic outlook. So far this year rising
oil prices have put a damper on what would have been a quick recovery by reducing overall
growth by one-half to three-quarters of a percent2. The higher oil prices have not raised inflation
noticeably. This alone would indicate that the fed would probably not raise interest rates during
the next meeting in December. However, further declines in the dollar could encourage the Fed
to tighten.
Productivity
Slower growth in GDP combined with more hiring is squeezing productivity growth. The result
is that unit labor costs are going to rise and squeezing companies’ profit margins. Some
companies will initially absorb these costs, but as a clear trend emerges many will pass the costs
onto consumers. The rising prices may transform the benign commodity-driven price inflation
into something potentially more sinister. 3
Overall
The economy is expanding, although at a slower pace than expected. The Fed no longer has any
incentive to maintain the anti-deflationary policies it enacted in 2003. The rising oil and
consumer price levels combined with the widening trade deficit, all point to the fed raising
interest rates in the near future. History implies that the rate increase will not come until after
December 31st. The Fed has only raised interest rates one time during the month of December
through Greenspan’s tenure as chairman. The diversified financial industry is well poised to
have stable growth in the upcoming months, due to the expanding U.S. economy.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-1-
Sector Overview
The financial sector is a large and diverse component of the S&P 500, currently making up
20.93% of the index. The sector is comprised of banks, insurance, real estate, and diversified
financial companies for a combined market
Figure 1
capitalization of $2.18 trillion.
The sector can be categorized as both
mature and cyclical. The products offered in
each of the sub sectors are fairly
homogenous, giving the sector a commodity
orientation that limits profitability.4
Competition is extremely high and
efficiency is an important factor because
many new products and services are quickly
copied by competitors.
Utilities
2.85%
Energy
6.98%
Consumer
Staples
10.98%
Technology
15.66%
Telecom
3.69%
Industrials
11.54%
Materials
3.00%
The cyclical nature of the sector exhibits a
Financials
strong negative correlation between interest
Consumer
20.93%
Discretionary
rates and return on equity, relative to the
10.96%
S&P 500 (Figure 3). The negative
Health Care
correlation specifies that when interest rates
13.40%
increase, the return on equity decreases and
vice versa. It is important to note that while there is a strong negative correlation for the sector
as a whole, there are many different correlations for the industries within the sector.
For instance, securities brokerages and diversified financials have positive correlations with
interest rates, while
banks and insurance Figure 2
companies have
negative
correlations. Since
we expect rates to
increase in the next
six months, it is
logical that we
exam those
industries and
companies that
exhibit a positive
ROE – interest rate
correlation, such as
Citigroup.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-2-
Industry Overview
Citigroup is a member of the diversified financial industry within the financial sector. The
industry is cyclical, but for the more diversified firms like Citigroup, the industry is more stable.
This industry is comprised of firms like JP Morgan Chase and Prudential Financial. These
companies are involved in various aspects of financial services, such as credit cards, investment
banking, consumer finance, capital markets, retail banking, asset management, insurance and
wealth management, also known as private banking. The industry as a whole is mature but
several companies within the industry are growing through acquisition, Citigroup is one of them.
External Factors
In a very competitive industry that relies heavily on price competition, the most efficient
companies have the best profit margins. Technological innovation has allowed financial
companies to automate time and labor intensive processes and enhance their ability to match up
borrowers and lenders, regardless of geographic location. These advances have lead to improved
productivity and profitability. Further advances in information systems will continue to increase
productivity and profitability over the next decade.
The financial sector is heavily regulated and the government can have an immediate and material
impact on a financial company’s stock price. The insurance company, Marsh & McLennan
(MMC) lost twenty-five percent of its market capitalization in one day after news about an
impending investigation by New York Attorney General Elliot Spitzer broke. This represents an
additional risk to shareholders, who may unwittingly invest in a company that engages in illegal
activities. In the past year, Citigroup has had to set aside $5 billion to deal with financial and
legal matters relating to the Enron and WorldCom scandals.
The diversified financial sector does business on a global scale and is faced with new
competition daily. Citigroup, for example, is in over one hundred different countries on six
continents. There is not a severe risk from foreign influence. The greatest risk for Citigroup is
from two or more large financial companies combining. The newly combined company would
possibly be able to offer the economies of scale and geographic coverage comparable to
Citigroup.
Demand Analysis
The “graying’ of America is changing the demand for financial services. As the baby boomers
become older and more affluent, they will have more and more money to invest in the equity and
fixed income markets. Customers are becoming more focused on the need to accumulate
adequate savings for retirement, to protect these savings and to plan for the transfer of wealth to
the next generation. People are also living longer, and as a result there will be increased demand
for insurance products, especially products that cover long-term care for people who need
constant medical attention.
In the long run, there will always be demand for credit cards, mortgages business loans or
insurance in one form or another. Financial services are the backbone of our economy and will
continue to be for years to come. Because diversified financials offer such a wide range of
products, they are able position their companies to tap changing demand for different products.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-3-
World population is continuing to expand at an exponential rate. It is important for companies
within the industry position themselves in developing countries to take advantage of exploding
populations, especially in Asia and India.
Supply Analysis
There are a large number of competitors in most of the markets that Citigroup competes in. This
intense competition and the availability of substitutes limits companies’ pricing power.
Citigroup is well positioned to take advantage of this apparent downside, due to the size of the
company and their ability to leverage economies of scale. The industry’s competitive landscape
will continue to consolidate in the coming years, but will still remain an industry competing
largely on price.
Earnings Outlook
The profits of Citigroup and the other diversified financials are tied to GDP growth that we
expect to continue to grow. In Figure 4, notice the strong positive correlation between GDP and
EPS for the diversified financial sector. Since GDP is expected to rise in the coming year, one
can assume that EPS will rise as well. EPS has always been a key driver of stock price for the
financial sector. EPS are typically higher for the diversified financial industry than for the sector
as a whole (Figure 5).
Figure 3
Industry Financial and Valuation Analysis
The industry typically
has a greater price to
year forward earnings
multiple then the
sector (Figure 5).
This is due to the fact
that there is more
growth within the
Figure 4
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-4-
diversified financial industry than in most of the other industries in the sector. The industry’s
P/E is currently below the mean and is in a stable trend (Figure 5). In absolute terms, the P/E
year forward at 12.6, is below its historic mean of 14.0. This indicates that the industry is
currently inexpensive. The industry price to book ratio is slightly above its historic mean relative
to the financial sector (Figure 5), but it is currently below its mean in absolute terms. The
industry earnings per share are trending upwards relative to the sector and are significantly above
the mean (Figure 4). The strong upward trend is encouraging, but current values that are much
higher than the mean may indicate that earnings are not maintainable at this level.
Figure 5
Earnings growth year-over-year is strong for
the industry. For the past seven quarters the
industry has been able to grow earnings
(Figure 6). With improving economic
conditions, this trend is expected to continue
over the next year.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
Figure 6 - Diversified Financial Industry EPS
-5-
The gray bars in Figure 7 illustrate the recession that the U.S. economy faced during 2001. It is
important to note how well the diversified financials were able to increase earnings relative to
the sector during the recession. Although the economic condition is no where near a recession, it
is important to note that the diversified financials industry can thrive in any business
environment.
Figure 7
The sector offers a dividend yield of 2.3%. This is above the S&P 500’s of 1.7%. The dividend
yield in absolute and relative terms is above the mean and it appears that the dividend has
stabilized at a new level (Figure 7). The growth rate is currently below the mean. If history is
any indication of its future trend, then one would expect the growth rate to revert upwards
towards the mean.
There is an interesting positive correlation between the federal funds rate and the diversified
financial industry’s ROE, relative to the S&P 500 (Figure 8). Since rates are expected to go up
in the next year, we can assume that the return on equity relative to the S&P 500 will increase
too.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-6-
Overall Industry Assessment
The diversified financial industry
is growing and will continue to
grow as the U.S. population ages
and the economy expands. The
demand for different types of
financial services may change but
the aggregate demand will
increase. Diversified companies
within the sector seek to benefit
from this increased demand if they
can listen to their customers and
Figure 8
provide that service.
Consolidation within the industry will continue as more and more companies enter the ranks of
the diversified financials. Competition will continue to be primarily based on price and efficient
companies will be the most successful.
The long term outlook is also especially pleasant as the world’s population grows. Firms need to
take advantage of growth outside the U.S., especially in developing countries where population
is exploding. Citigroup is especially well positioned to take advantage of emerging markets. It
currently generates roughly 40% of its revenue from outside the United States and that
percentage is likely to grow.
The diversified financials are currently cheap on an absolute basis. Price-to-forward year
earnings and price to book values are below their means. Earnings growth looks like it will
continue for the industry as GDP expands. With the expansion of GDP we can also expect to see
rising interest rates. The rising rates would lead to rising ROE for the industry.
A healthy dividend and an ample growth rate make the diversified financial sector very
attractive. The diverse nature of the companies within the industry adds another layer of
diversification to our SIM portfolio.
We elect to maintain our current overweight position in the sector and in the diversified financial
industry.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-7-
Company Overview5
Citigroup Inc. is a diversified global financial services holding company whose businesses
provide a broad range of financial services to consumer and corporate customers with some 200
million customer accounts doing business in more than 100 countries. Citigroup was
incorporated in 1988.
The Company's activities are conducted through the Global Consumer, Global Corporate and
Investment Bank (GCIB), Private Client Services, Global Investment Management (GIM) and
Proprietary Investment Activities business segments.
At December 31, 2003, the Company had approximately 134,000 full-time and 6,000 part-time
employees in the United States and approximately 119,000 full-time employees outside the
United States.
GLOBAL CONSUMER
Global Consumer delivers a wide array of banking, lending, insurance and investment services
through a network of local branches, offices and electronic delivery systems, including ATMs,
Automated Lending Machines (ALMs) and the World Wide Web. The Global Consumer
businesses serve individual consumers as well as small businesses. Global Consumer includes
Cards, Consumer Finance and Retail Banking.
Cards provides MasterCard, VISA and private label credit and charge cards. North America
Cards includes the operations of Citi Cards, the Company's primary brand in North America, and
Mexico Cards. International Cards provides credit and charge cards to customers in Europe, the
Middle East and Africa (EMEA), Japan, Asia and Latin America.
Consumer Finance provides community-based lending services through branch networks,
regional sales offices and cross-selling initiatives with other Citigroup businesses. The business
of CitiFinancial is included in North America Consumer Finance. As of December 31, 2003,
North America Consumer Finance maintained 2,328 offices, including 2,082 CitiFinancial
offices in the U.S. and Canada, while International Consumer Finance maintained 875 offices,
including 552 in Japan. Consumer Finance offers real-estate-secured loans, unsecured and
partially secured personal loans, auto loans and loans to finance consumer-goods purchases. In
addition, CitiFinancial, through certain subsidiaries and third parties, makes available various
credit-related and other insurance products to its U.S. customers.
Retail Banking provides banking, lending, investment and insurance services to customers
through retail branches and electronic delivery systems. In North America, Retail Banking
includes the operations of Citibanking North America, Consumer Assets, CitiCapital, Primerica
Financial Services (Primerica), and Mexico Retail Banking. Citibanking North America delivers
banking, lending, investment and insurance services through 779 branches in the U.S. and Puerto
Rico and through Citibank Online, an Internet banking site on the World Wide Web. The
Consumer Assets business originates and services mortgages and student loans for customers
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-8-
across the U.S. The CitiCapital business provides leasing and equipment financing products to
small- and middle-market businesses. The business operations of Primerica involve the sale,
mainly in North America, of life insurance and other products manufactured by its affiliates,
including Smith Barney mutual funds, CitiFinancial mortgages and personal loans and the
products of our Life Insurance and Annuities business. The Primerica sales force is composed of
over 100,000 independent representatives. Mexico Retail Banking consists of the branch banking
operations of Banamex. International Retail Banking provides full-service banking and
investment services in EMEA, Japan, Asia, and Latin America. The Commercial Markets Group
is included in Retail Banking and consists of the operations of CitiCapital, as well as middlemarket lending operations in North America and the international regions.
GLOBAL CORPORATE AND INVESTMENT BANK
Global Corporate and Investment Bank (GCIB) provides corporations, governments, institutions
and investors in approximately 100 countries with a broad range of financial products and
services. GCIB includes Capital Markets and Banking, Transaction Services and Other
Corporate.
Capital Markets and Banking offers a wide array of investment and commercial banking services
and products, including investment banking, debt and equity trading, institutional brokerage,
advisory services, foreign exchange, structured products, derivatives, and lending.
Transaction Services is composed of Cash Management, Trade Services and Global Securities
Services (GSS). Cash Management and Trade Services provide comprehensive cash
management and trade finance for corporations and financial institutions worldwide. GSS
provides custody services to investors such as insurance companies and pension funds, clearing
services to intermediaries such as broker/dealers and depository and agency/trust services to
multinational corporations and governments globally.
PRIVATE CLIENT SERVICES
Private Client Services provides investment advice, financial planning and brokerage services to
affluent individuals, small and mid-size companies, non-profits and large corporations primarily
through a network of more than 12,200 Smith Barney Financial Consultants in more than 500
offices worldwide. In addition, Private Client Services provides independent client-focused
research to individuals and institutions around the world.
A significant portion of Private Client Services revenue is generated from fees earned by
managing client assets as well as commissions earned as a broker for its clients in the purchase
and sale of securities. Additionally, Private Client Services generates net interest revenue by
financing customers' securities transactions and other borrowing needs through security-based
lending. Private Client Services also receives commissions and other sales and service revenues
through the sale of proprietary and third-party mutual funds. As part of Private Client Services,
Global Equity Research produces equity research to serve both institutional and individual
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-9-
investor clients. The majority of expenses for Global Equity Research are allocated to the Global
Equities business within GCIB and Private Client Services businesses.
GLOBAL INVESTMENT MANAGEMENT
Global Investment Management (GIM) offers a broad range of life insurance, annuity, asset
management and personalized wealth management products and services distributed to
institutional, high-net-worth and retail clients. Global Investment Management includes Life
Insurance and Annuities, Private Bank and Asset Management.
Life Insurance and Annuities comprises Travelers Life and Annuity (TLA) and International
Insurance Manufacturing (IIM). TLA offers individual annuity, group annuity, individual life
insurance and Corporate Owned Life Insurance (COLI) products. The individual products
include fixed and variable deferred annuities, payout annuities, and term, universal, and variable
life insurance. These products are primarily distributed through CitiStreet Retirement Services
(CitiStreet), Smith Barney, Primerica, Citibank and affiliates, and a nationwide network of
independent agents and the outside broker dealer channel. The COLI products are variable
universal life products distributed through independent specialty brokers. The group products
include institutional pensions, including guaranteed investment contracts (GICs), payout
annuities, group annuities sold to employer-sponsored retirement and savings plans, structured
settlements and funding agreements. IIM provides annuities, credit, life, health, disability and
other insurance products internationally, leveraging the existing distribution channels of the
Consumer Finance, Retail Banking and Asset Management (retirement services) businesses. IIM
has operations in Mexico, Asia, EMEA, Latin America and Japan. TLA and IIM include the
realized investment gains/(losses) from sales on certain insurance-related investments.
Private Bank provides personalized wealth management services for high-net-worth clients
through 126 offices in 37 countries and territories, generating fee and interest income from
investment funds management, client trading activity, trust and fiduciary services, custody
services, and traditional banking and lending activities. Through its Private Bankers and Product
Specialists, Private Bank leverages its extensive experience with clients' needs and its access to
Citigroup to provide clients with comprehensive investment and banking services.
Asset Management includes Citigroup Asset Management, Citigroup Alternative Investments
Institutional business, Banamex asset management and retirement services businesses and
Citigroup's other retirement services businesses in North America and Latin America. These
businesses offer institutional, high-net-worth and retail clients a broad range of investment
alternatives from investment centers located around the world. Products and services offered
include mutual funds, closed-end funds, separately managed accounts, unit investment trusts,
alternative investments (including hedge funds, private equity and credit structures), variable
annuities through affiliated and third-party insurance companies, and pension administration
services.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-10-
PROPRIETARY INVESTMENT ACTIVITIES
Proprietary Investment Activities is comprised of Citigroup's proprietary Private Equity
investments and Other Investment Activities which includes Citigroup's proprietary investments
in hedge funds and real estate investments, investments in countries that refinanced debt under
the 1989 Brady Plan or plans of a similar nature, ownership of Travelers Property Casualty Corp.
shares and Citigroup's Alternative Investments (CAI) business, for which the net profits on
products distributed through Citigroup's Asset Management, Private Client Services and Private
Bank businesses are reflected in the respective distributor's income statement through net
revenues.
INTERNATIONAL
Citigroup International (whose operations are fully reflected in the product disclosures above)
serves 54 million customer accounts in approximately 100 countries, working in partnership with
the Company's product organizations.
Citigroup International is organized by region-Asia, EMEA, Japan, and Latin America. Citigroup
has a long history in each of these regions, including more than 100 years in a number of
countries. The markets we serve account for 85% of the world's population and 65% of its GDP.
In Asia in 2003, consumer growth was driven by new wealth management initiatives and
expanding credit card activities. In large and growing markets like India and China, we are wellpositioned to build market share across the spectrum of consumer products. In January 2003, we
established a strategic alliance with the Shanghai Pudong Development Bank, which led in
February 2004 to the issuance of a dual currency credit card in China, in cooperation with
Citibank. The GCIB continued to gain market share with new products, expansion of our
customer base, and significant deals such as the underwriting of China Life's $3 billion Initial
Public Offering.
EMEA's earnings were driven by increased sales and substantial cost reduction. The GCIB had
strong market share gains, ranking number one in the region in debt and equity underwriting.
Retail Banking is our largest consumer business, with a strong presence particularly in Germany.
A highlight was the launch of our credit card in Russia, and we continue to expand our consumer
offerings in Poland, Italy and Spain. Citigroup also introduced wealth management programs in
countries in Eastern Europe and the Middle East.
Citigroup is Japan's number one foreign corporate bank and consumer bank, and one of the
largest consumer finance firms.
Nikko, our investment banking joint venture, was one of Japan's top equity underwriters and in
2003, was the top mergers and acquisitions advisor in Japan, advising on the Japan Telecom and
Resona transactions. Our Private Bank and joint venture with Mitsui Sumitomo Insurance are
fast-growing market leaders.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-11-
Citigroup's Latin America operations returned to profitability in 2003. Citigroup has been a
leader for 90 years in Latin America, a region that is once again attracting investment. We
implemented a successful repositioning of our business in the region that is expected to achieve
positive results by aligning investment with the greatest opportunities for returns. In Brazil, we
launched a consumer finance business targeting the large retail credit market and opened nine
branches in S o Paulo. Citigroup concluded the first-ever Venezuela domestic liability
management transaction, completed Costa Rica's first international syndication, and acted as deal
manager and global coordinator of the landmark $5.3 billion bond swap for Uruguay.
COMPANY ANALYSIS
Figure 9
Citigroup is a growing
Asset Management
company in a cyclical sector. It
2%
furthers its growth through the
Citigroup Private Bank
use of fill-in acquisitions that
3%
help the company earn a
Life Insurance &
growing profit, year after year.
Annutites
Credit Cards
5%
In 2003, it earned a profit of
20%
$17.9 Billion, which was up
Transaction Services
5%
16.9% from the year prior. As
a diversified financial company
its earnings come from a
number of different sources.
As described above, Citigroup
Conusmer Finance
Capital Markets &
11%
has a number of diverse
Banking
businesses in numerous
25%
geographic locations. Because
many of its businesses are very
different, it is important to drill
down and to see where the
Retail Banking
Private Client Services
various streams of income are
24%
5%
coming from. Figure 9 shows
us that 80% of Citigroup’s net
income comes from four sources: credit cards, capital markets and banking, retail banking and
consumer finance. To fully understand how Citigroup operates and where it is going, we must
explore these four divisions.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-12-
Credit Cards
In 2003, Credit cards contributed $3.6 Billion dollars to the company’s bottom line, up from $3.1
Billion the year before (Figure 11). Over the past five years
Figure 10
credit card growth has averaged 21% per year and doesn’t
show any signs of slowing. Along with its agreement with gas
provider Royal Dutch Shell to provide credit card services,
Citigroup purchased the credit card business of Sears and
Home Depot in 2003. These acquisitions make it the number
one private label credit card provider in the U.S.. The
company is also expanding abroad. In 2002, Citigroup entered
into a strategic alliance with the Shanghai Pudong
Development Bank to enter the Chinese credit card market.
Although the company has only a small, five percent stake, in
this alliance, this is the beginning of the firm’s entrance into
the giant Chinese market. In July of 2003, Citigroup acquired
Diners Club Europe and expanded operations into Russia with
the first credit card by an international financial institution.
Citigroup is looking to further its penetration into the Asian,
Latin American and Japanese markets. There is great growth potential in the foreign credit card
market and through its acquisitions and organic growth, Citigroup has placed itself in a favorable
position to profit from it.
Citigroup has also been able to improve the credit quality within its card portfolio. The
provision for credit losses was down 13.9% from 2002 even through revenues increased 7.2%
(Figure 11). This credit discipline will be of a great benefit to the company going forward and
will allow them to directly increase net income.
Figure 11
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-13-
Figure 3
Capital Markets & Banking
Capital Markets and Banking
Profits in the capital markets and banking unit were up
year over year by 15.9%. Most of this increase can be
attributed to the 63.9% decrease in the provision for credit
losses. The unit only achieved a 4.4% increase in revenue
(Figure13). It was hurt by increases in overall business
spending as the economy slowed down but has reorganized
its Latin American operations and will be in good shape as
the economy grows
Much like the acquisitions in the credit card unit, the
capital markets and banking unit has seen aquisions as
well. In the summer of 2004, Citigroup purchased Lava Trading and Knight Trading’s
derivatives business.
Citigroup plans on improving the unit’s results in the coming year by expanding market share
positions and outperforming the industry, credit risk mitigation, and expense management. While
initiatives will focus on expanding market share in priority countries through organic growth,
revenue and credit performance was dependent upon the strength and stability of U.S. and global
economic conditions. Citigroup continues to monitor the economic situation in emerging market
countries closely and, where appropriate, adjusts exposures and pursues risk management
initiatives.6
Figure 4
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-14-
Figure 5
Retail Banking
Retail banking was up 15.7% primarily because of the
acquisition of Golden State Bancorp in May of 2002.
Strong growth in customer volumes, including mortgage
originations as well as loan and deposit balances, helped
spur growth. Citigroup attributes the lower provision for
credit losses to lower credit costs in Mexico, which pushed
net income up a staggering 37% (Figure 13).
In 2004, Citigroup acquired First American Bank of Texas
and Principle Residential Mortgage. The outlook is not
clear for the retail banking unit. As interest rates rise, the
yield curve will flatten out squeezing banks profits. Aside
from the yield curve issue, there will be less volume from consumers originating mortgages. To
try and alleviate the changing external environment the company is planning on emphasizing
increased sales productivity in the financial centers, deeper customer relationships through crossselling and wealth management initiatives, and further investments in technology that drive cost
efficiencies and improve customer satisfaction.
Figure 6
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-15-
Figure 7
Consumer Finance
Consumer finance makes up 11% of the total income
(Figure 9). It is also the only unit of the four largest to
have decreased net revenues in 2004. It decreased revenue
by 12.3% from 2003 (Figure 15). Citigroup cites
declining international consumer financing, especially in
Japan as the culprit for the decline.
The company has made strategic acquisitions to shore up
the unit. In 2004, the company acquired Washington
Mutual’s consumer finance business for $1.25 Billion.
The company thinks that the improving economy, further
acquisitions, and additional cross-selling of its products
will help the unit to return to earnings growth. Weakness
in Japan is expected to continue but important growth
opportunities are anticipated as Citigroup focuses on gaining market share in both new and
established markets including India, Poland, Romania, Italy, South Korea, and Thailand.
Figure 8
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-16-
Opportunities for Growth
Citigroup enters 2004 well-positioned for continued growth with leading market positions, global
scale, well-respected brand names, a strong distribution network and the largest capital base of
all financial institutions. The investment spending in the past year, coupled with increased
customer balances, positions the company for growth in the coming years. In the consumer
business, Citigroup intends to leverage the newly-formed alliances with Sears and The Home
Depot. The Company is targeting expansion of its Cards and Retail Banking businesses,
particularly in India and China. In the Global Corporate and Investment Bank, management is
focused on exploiting the opportunities in global equities, mergers and acquisitions advisory
services, and derivatives. The Private Client Services business expects improving market
conditions to increase transaction volumes and assets under management. Equity research
coverage will be expanded in targeted sectors. The Life Insurance and Annuities and Asset
Management businesses are well-positioned to benefit from the growth in the aging population.7
Citigroup’s disciplined strategy of fill-in acquisitions has allowed it to take advantage of
synergies and extract efficiencies. For example, by taking over both Sears and Home Depot
credit cards, the company can combine call centers and eliminate redundant processing systems.
This type of successful acquisition strategy will continue to be a great source of growth for the
company.
Risks to Growth
Citigroup's results are closely tied to the external economic environment. Weakness in global
economies, credit deterioration and the continued threat of terrorism are examples of downside
risk that could impact future earnings. The consumer business is sensitive to changes in
unemployment, bankruptcy and consumer confidence levels. Competition in Life Insurance and
Annuities and Asset Management continues to intensify and revenues are sensitive to overall
equity and fixed income market conditions. These two businesses remain exposed to downside
risk in Argentina's economy and government actions.8
Scandals
Citigroup has been at the center of a number of scandals during the past two years. In 2003, the
company paid $400 million in fines for issuing favorable stock ratings to companies in exchange
for investment banking contracts. This practice, known as spinning, has since been eliminated
by separating the stock picking and corporate advisory businesses.
In May of 2004, Citigroup was ordered to pay $2.65 Billion to investors who were burned when
telecommunications giant, WorldCom went bankrupt. Citigroup was one of the lead
underwriters of WorldCom stocks and bonds. In the wake of these proceedings, Citigroup has
set aside $5 Billion to deal with further litigation relating to the WorldCom and Enron scandals.
The latest scandal happened in September 2004, when Japanese regulators pulled the plug on
Citigroup’s private banking operations after they determined the company misled investors.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-17-
Citigroup was quick to dismiss three top executives in the private banking and asset management
units.
The scandals represent a material threat to Citigroup’s bottom line. New CEO Chuck Prince has
made it a priority to change the corporate culture and restore faith in the company.
Financial Statement Analysis
Citigroup has been able to increase net income by an average of 12.4% per year since 1999.
Even during 2001 when revenues were falling because of a downturn in the economy, they were
able to increase their net profit. Citigroup is a company that exercises good expense discipline.
If you notice, revenue growth was 8.6% and 5.9% for 2003 and 2002, respectively, while
operating expenses grew at only 5.0% and 2.1% for 2003 and 2002, respectively (Figure 16).
Citigroup’s strong commitment to cost cutting is a major theme for the company. It plans on
spending money in the coming year to upgrade and improve the many of their information
systems. This improved productivity will bode well for the company in the coming years,
helping it to continue the trend of yearly increases in the profit margin.
Figure 9
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-18-
Earnings and earnings per share have increased for the past seven quarters (Figure 17). This type
of trend is expected to continue as the economy improves and the latest acquisitions are fully
integrated into the Citigroup platform and made more efficient.
Figure 10
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-19-
A look at the balance sheet (Figure 18) indicates that every asset account has improved from
2002. Investment securities increased because there was an increase in client driven demand for
treasury and federal agency securities. Loans increased primarily due to the purchase of Home
Depot and Sears’ receivables.
Deposits are the company's largest source of funding. They are derived from Citigroup’s large,
geographically diverse deposit base. The increase in deposits is driven by increases in corporate,
retail and private banking deposits. The large increase in long-term debt is because the company
took advantage of low interest rates and the positive credit environment to extend the maturities
of new borrowings. A larger balance sheet with greater detail is available in the analysis
spreadsheet.
Figure 11
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-20-
The analysis of the statement of cash flows indicates that there has been an increase of 442% in
business acquisitions in 2003. (Statement of Cash Flows is located in the spreadsheet analysis).
This large increase is not surprising given the corporate plan of growth partially through
acquisition. It is expected that the rate of new acquisitions will slow in the coming year, but will
continue to be increase year over year. The company increased its dividend by 57% during
2003. The geometric mean for dividend growth for the past three years is 26%. In 2003,
Citigroup was able to increase its issuance of long-term debt by 69%. This comes as no surprise
as everyone wanted to take advantage of lower interest rates.
A review of key financial ratios reveals that Citigroup has a much higher ROE than the industry,
the market and one of its primary competitors. Its return on assets beats the industry and JP
Morgan but falls short of the S&P 500. Net profit margin is currently lagging behind the
industry but this trend is not expected to continue. Citigroup is firmly committed to reducing
costs and this will help improve the profit margin over the coming year.
Figure 12
Citigroup JP Morgan Industry S&P 500
20.40%
13.70% 16.90%
17.10%
Return on Equity
1.10%
0.40%
1.00%
2.10%
Return on Assets
15.85%
9.32% 16.86%
8.10%
Net Profit Margin
Forecasted Financials
All forecasted financials can be found in the accompanying spreadsheet. Below is a summary of
that spread sheet.
Earnings Per Share
Earnings Growth
Net Profit Margin
Dividend Per Share
ROE
2003
3.42
16.9%
15.85%
1.60
20.40%
2004E
4.45
29.4%
22.28%
2.02
18.4%
2005E
4.92
10.6%
23.32%
2.54
18.2%
Expansion of market share, improvements in newly acquired businesses and an improvement in
the overall health of the economy will help grow earnings per share over the next two years. The
competitive nature of the industry will force costs down and help the net profit margin to grow to
23.32% by 2005. The increase in profit will be accompanied by an expanding dividend of $2.02
and 2.54 in 2004 and 2005, respectively. The ROE will decline toward its historic mean during
the next two years.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-21-
COMPANY VALUATION
Figure 13
Currently Citigroup stock looks relatively inexpensive. It is currently trading below its mean for
absolute price to year-forward earnings and relative price to year-forward earnings to the sector.
The price to book value also indicates that the stock is cheap (Figure 20). All four measures
give merit to the stock being undervalued.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-22-
Citigroup stock has a correlation between the federal funds rate and the return on equity relative
to the S&P 500. While not a perfect correlation the federal funds rate does offer a glimpse into
the future direction and magnitude of ROE. Our current environment indicates that interest rates
will be rising. Therefore, we can expect Citigroup ROE to rise as well. One troubling indicator is
that the absolute ROE is at a very high level. Mean reversion would indicate that the ROE will
eventually fall lower, towards the mean.
It would appear looking at historic data that the current price of Citigroup, at $45.40, is
undervalued. The question is, by how much? Using current industry averages as well as
Citigroups’ own historic averages the fair price can be derived.
Figure 14
Price to
Price to
Price to
Price to
Price to
Price to
Price to
Price to
TTM Earnings – Current Industry Avg.
TTM Earnings - 5 yr Citigroup Avg.
TTM Sales – Current Industry Avg.
TTM Sales - 5 yr Citigroup Avg.
TTM Book – Current Industry Avg.
TTM Book - 5 yr Citigroup Avg.
Yr Fwd Earnings - Current Industry Avg.
Yr Fwd Earnings - 5 yr Citigroup Avg.
Average
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-23-
Stock Price
45.68
55.37
52.91
48.10
45.81
61.74
53.38
57.38
52.55
From Figure 21, it is clearly evident that the Citigroup is undervalued. Of the nine methods used
to derive the price, not one is below the current market price of 45.40. The average of the nine is
52.55. Based on this method of estimating fair value, the stock price is currently 15.63%
undervalued.
The dividend discount model is another method of determining the fair price of a stock.
About the Model:
The rate for a ten year
treasury bond is used for the
risk-free rate. The 4% Market
risk premium is taken from a
Yale University study that
looked at historic returns of
stocks versus risk-free bond
investments9. The study came
up with a arithmetic mean of
4% for an market risk
premium. The required rate
of return and the growth rate
are calculated values. Because
Citigroup’s performance is
influenced largely by the
economy, the GDP growth
rate plus inflation is used to
determine the long-term
growth potential of the
company. After all of the
dividends have been
discounted back to the current
year, the projected price is
determined to be 71.52. This
would indicate that the current
market price of one share of
Citigroup stock, at 45.40, is
undervalued by 58%.
Figure 15
Risk Free Rate
Market Risk Premium
Stock Beta
4.36%
4.0%
1.29
K (Required Return)
9.52%
ROE
Plowback Ratio
20.4%
67.66%
Growth
Long Term Growth
13.80%
6.30%
Current Dividend
1.60
Year
0
1
2
3
4
5
6
Dividend
1.60
1.82
2.07
2.36
2.68
3.05
3.48
PV of CF
1.66
1.73
1.80
1.87
1.94
8.99
PV of CF from Year 6 Fwd
PV of CF from Year 6 to yr 1
Projected Price
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-24-
107.91
62.53
71.52
Price Momentum
Figure 16
Current Price momentum indicates that the stock is currently slightly oversold, as illustrated in
Figure 23.
Valuation Summary
Several different methods were used to determine the fair value of Citigroup stock. Each method
pointed to the same conclusion, the stock is undervalued. The amount it is undervalued ranged
from .6% to 57.5%. Based an average of all ten quantitative techniques, the fair value is
estimated to be 54.44.
Price target: 54.44
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-25-
Recommendation
Citigroup’s stock has had to weather numerous scandals in the previous two years which has
caused it to become undervalued. As the legal and regulatory storm passes, the stock price will
rise as investors discover the value in the company.
Citigroup is actively committed to growing its core businesses through fill-in acquisitions and
organic growth. As this growth continues, a greater percentage of the earnings will come from
foreign markets. The growth strategy fits the company well because it has perfected the process
of identifying undervalued companies, and then executing a successful take over. By following
this strategy, the company will become even further diversified over time.
With GDP and interest rates increasing, Citigroup stands to take advantage of this cyclical
growth. Even if the economic expansion does not meet expectations the credit and operating
expense discipline that the company exercises will lead to increased profits. The overall outlook
for Citigroup is very good.
Our recommendation is to maintain our current overweight position of 1.58% in the
financial sector.
Increase our holdings in Citigroup by an additional 1.2%.
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-26-
References
1.
2.
3.
4.
5.
6.
7.
8.
9.
Goldman Sachs, “Pocket Chartroom”. August/September 2004
The Wall Street Journal. “The Economy; The Outlook”. November 1, 2004. pg. A2
Goldman Sachs, “Pocket Chartroom”. August/September 2004
Hooke, Jeffery C., Security Analysis on Wall Street. 1998
Citigroup Inc 2003 10K
Citigroup Inc 2003 10K
Portions taken from the Citigroup Inc 2003 10K
Portions taken from the Citigroup Inc 2003 10K
Yale International Center for Finance, http://icf.som.yale.edu/pdf/Supply(v5).pdf .The
supply of stock market returns
Brandon Seibert, Fisher College of Business
Citigroup Inc. – November 30, 2004
-27-