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  1. 1. 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-
  2. 2. 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 capitalization of $2.18 trillion. Figure 1 The sector can be categorized as both Technology 15.66% Telecom mature and cyclical. The products offered in Utilities each of the sub sectors are fairly 3.69% 2.85% homogenous, giving the sector a commodity Energy Industrials orientation that limits profitability.4 6.98% 11.54% Competition is extremely high and Materials efficiency is an important factor because Consumer 3.00% many new products and services are quickly Staples copied by competitors. 10.98% The cyclical nature of the sector exhibits a Financials strong negative correlation between interest Consumer 20.93% rates and return on equity, relative to the Discretionary S&P 500 (Figure 3). The negative 10.96% 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-
  3. 3. 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-
  4. 4. 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-
  5. 5. 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 Figure 6 - Diversified Financial Industry EPS Citigroup Inc. – November 30, 2004 -5-
  6. 6. 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-
  7. 7. 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-
  8. 8. 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-
  9. 9. 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 middle- market 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-
  10. 10. 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-
  11. 11. 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 well- positioned 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-
  12. 12. 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 company in a cyclical sector. It Asset Management 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 In 2003, it earned a profit of 5% 20% $17.9 Billion, which was up Transaction Services 16.9% from the year prior. As 5% a diversified financial company its earnings come from a number of different sources. As described above, Citigroup Conusmer Finance has a number of diverse Capital Markets & 11% businesses in numerous Banking 25% geographic locations. Because many of its businesses are very different, it is important to drill down and to see where the various streams of income are Private Client Services Retail Banking 5% 24% 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-
  13. 13. 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 credit card growth has averaged 21% per year and doesn’t Figure 10 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-
  14. 14. Figure 3 Capital Markets and Banking Capital Markets & 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-
  15. 15. 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 cross- selling 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-
  16. 16. 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-
  17. 17. 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-
  18. 18. 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-
  19. 19. 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-
  20. 20. 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-
  21. 21. 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 Return on Equity 20.40% 13.70% 16.90% 17.10% Return on Assets 1.10% 0.40% 1.00% 2.10% Net Profit Margin 15.85% 9.32% 16.86% 8.10% Forecasted Financials All forecasted financials can be found in the accompanying spreadsheet. Below is a summary of that spread sheet. 2003 2004E 2005E Earnings Per Share 3.42 4.45 4.92 Earnings Growth 16.9% 29.4% 10.6% Net Profit Margin 15.85% 22.28% 23.32% Dividend Per Share 1.60 2.02 2.54 ROE 20.40% 18.4% 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-
  22. 22. 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-
  23. 23. 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 Stock Price Price to TTM Earnings – Current Industry Avg. 45.68 Price to TTM Earnings - 5 yr Citigroup Avg. 55.37 Price to TTM Sales – Current Industry Avg. 52.91 Price to TTM Sales - 5 yr Citigroup Avg. 48.10 Price to TTM Book – Current Industry Avg. 45.81 Price to TTM Book - 5 yr Citigroup Avg. 61.74 Price to Yr Fwd Earnings - Current Industry Avg. 53.38 Price to Yr Fwd Earnings - 5 yr Citigroup Avg. 57.38 Average 52.55 Brandon Seibert, Fisher College of Business Citigroup Inc. – November 30, 2004 -23-
  24. 24. 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: Figure 15 The rate for a ten year treasury bond is used for the Risk Free Rate 4.36% risk-free rate. The 4% Market Market Risk Premium 4.0% risk premium is taken from a Stock Beta 1.29 Yale University study that looked at historic returns of K (Required Return) 9.52% stocks versus risk-free bond investments9. The study came ROE 20.4% up with a arithmetic mean of Plowback Ratio 67.66% 4% for an market risk premium. The required rate Growth 13.80% of return and the growth rate Long Term Growth 6.30% are calculated values. Because Citigroup’s performance is Current Dividend 1.60 influenced largely by the economy, the GDP growth Year Dividend PV of CF rate plus inflation is used to 0 1.60 determine the long-term 1 1.82 1.66 growth potential of the 2 2.07 1.73 company. After all of the 3 2.36 1.80 dividends have been 4 2.68 1.87 discounted back to the current 5 3.05 1.94 year, the projected price is 6 3.48 determined to be 71.52. This 8.99 would indicate that the current market price of one share of PV of CF from Year 6 Fwd 107.91 Citigroup stock, at 45.40, is PV of CF from Year 6 to yr 1 62.53 undervalued by 58%. Projected Price 71.52 Brandon Seibert, Fisher College of Business Citigroup Inc. – November 30, 2004 -24-
  25. 25. 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-
  26. 26. 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-
  27. 27. References 1. Goldman Sachs, “Pocket Chartroom”. August/September 2004 2. The Wall Street Journal. “The Economy; The Outlook”. November 1, 2004. pg. A2 3. Goldman Sachs, “Pocket Chartroom”. August/September 2004 4. Hooke, Jeffery C., Security Analysis on Wall Street. 1998 5. Citigroup Inc 2003 10K 6. Citigroup Inc 2003 10K 7. Portions taken from the Citigroup Inc 2003 10K 8. Portions taken from the Citigroup Inc 2003 10K 9. Yale International Center for Finance, .The supply of stock market returns Brandon Seibert, Fisher College of Business Citigroup Inc. – November 30, 2004 -27-