"The Bull's Argument for Citigroup Shares" ISI's Citi Upgrade Explained (C)

This is our second post on the ISI call, see also yesterday's"The Inside Skinny On ISI Group's Citigroup Upgrade (C)"
From Barron's Hot Research:

In upgrading the bank to a Buy, International Strategy & Investment Group writes that the stock is still cheap relative to its growth potential. 

By International Strategy & Investment Group, Inc. ($4.15, Nov. 30, 2010)
WE ARE UPGRADING CITIGROUP to Buy and raising our price target to $5.50. [The firm's previous share price target for Citigroup's was $5.00.]
We have decided to upgrade Citigroup (ticker: C) for seven main reasons:

1) Given improving credit quality, excess loan loss reserves, and good cost control prospects, we now have more confidence in our near-consensus earnings-per-share (EPS) estimates of eight cents in fourth-quarter, 45 cents in 2011, and 56 cents in 2012;
2) We regard Citigroup as inexpensive at just 0.93 times tangible book and 7.4 times our 2012 EPS estimates;

3) Given its emerging markets footprint and its global transaction services (GTS) business, we think Citigroup has better long-term growth prospects than most of its competitors;
4) We regard Citigroup as having less mortgage repurchase risk than Bank of America (BAC) and JP Morgan Chase (JPM);
5) We do not think Citigroup will have to incur a deferred tax asset write-down;
6) Citigroup's Basel 3-based Tier one common equity ratio should grow very rapidly over the next two years, and
7) Citigroup is significantly "under-owned" by institutional investors and the U.S. Treasury stake is down to about 12%.

Thus, we think there could be considerable pent-up demand for Citigroup over the next 6-to-12 months.
All of these factors are potential catalysts for the stock.
We foresee considerable return of capital in 2012 and beyond: We currently estimate Citigroup's Basel 3-based Tier 1 common equity ratio at only about 6% (below the 7% Basel 3 threshold).
Thus, we do not expect Citigroup to return capital in 2011.
However, we look for that ratio to grow to about 8.3% by year-end 2011, which should position Citigroup to return considerable capital to shareholders in 2012 and beyond in the form of both dividends and stock buybacks.

We estimate Citigroup could return more than $15 billion to shareholders in both 2012 and 2013 and continue to operate in the 8-to-9% range on Tier 1 common equity.
Credit improvement and excess reserves support near-term EPS; emerging markets and (GTS) support long-term growth:

We estimate total revenue will drop by 10% in 2011 versus 2010 (which is already reflected in the third-quarter 2010 run-rate) and remain flat in 2012 due to a tough revenue backdrop for banks and the ongoing divestiture of Citi Holdings.
Nevertheless, we still think credit quality improvement, loan loss reserve recapture (Citigroup's reserve is robust at $44 billion), and good expense control will drive EPS to about 45 cents next year and about 56 cents in 2012.

Longer-term, we think EPS growth will be supported by Citigroup's presence in emerging markets (43% of total revenue in 2010), Global Transaction Processing (11% of total revenue), and stock buybacks.
If Citigroup can reach the low-end of management's 1.25%-to-1.50% return on assets (ROA) target by 2013, we estimate its EPS would be about 70 cents.

Our one-year price target (PT) of $5.50 offers a 33% upside and is still based on fairly conservative assumptions.

Our one-year price target is primarily based on 1.1 times our year-end 2011 tangible book value estimate of $5.03, which we regard as reasonable given that we forecast a 2012 return on tangible common equity (ROTCE) of 11% and solid growth prospects from there.
Our price-target of $5.50 also equals 10 times our 2012 EPS estimate and less than eight times Citigroup's 2013 EPS potential.

--Edward Najarian
--Brian Bedell
--Dan Zuk
--Thang To

Also at Hot Research:

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