Citigroup (NYSE:C) is undergoing a new restructuring process under Jane Fraser’s aim to reduce management layers, improve global footprint and aggressively reduce redundant (senior) employees. We’ve already heard this kind of news in the past, and Citi has been around for a long time part of endless efforts to improve its structure while growing its business. After conducting a careful benchmarking analysis, we concluded that the current valuation is not low enough to account for the bank’s overall uncertainties and vulnerability. Much better opportunities are also available in the market in similar banking stocks.
Continuous effort: downsizing, reorganizing and improving will be more difficult than expected
One of the key facts that investors pointed out about Citi is the complex management and reporting structures that ran the bank. Given its large global footprint, the bank needs an articulate one oversight, but Citi went above and beyond. Almost all the main roles of “heads” in the main markets – North America, Asia and Europe – were occupied by two people (co-heads). The other major issue was reporting lines. While it is essential for a large bank to maintain high-quality checks and compliance, it is easy to generate repetitive and redundant activities that slow down processes and increase costs.
To deal with these two problems, Jane Fraser decided to act in two main ways: (1) reduce the number of older employees and (2) shorten the reporting lines. But so far we’re seeing some confusion as news stories covering the ongoing effort are highlighting. This week eFinancialCareers reported in the words of a senior banker at Citi with knowledge of the issues:
This seems to have been a way of rearranging itself into a group that vaguely resembles what Jane wants, but without anyone actually leaving, it’s just moving chairs.
The main issue seems to be that senior people like co-chairmen are being removed to be placed in non-executive roles. This will do very little in terms of reducing costs and instead perpetuate an even more confusing work environment. Also, it is unclear whether the second- and third-tier co-director structures will actually be removed, making efforts to reduce reporting weaker.
Also, the banker goes on to say:
In the old world, the geographic entity had all the power. Now, it is the sector teams that have priority
Citigroup’s other major weakness is its complex and extensive global footprint. It is the key to any restructuring plan to simplify it. However, it doesn’t seem to be happening yet. Instead, it seems like they are simply reversing the direction of the reporting hierarchy rather than cutting out the “middlemen”.
Last but not least, Citi has also announced new reportable segments.
These will be new from the end of 2023 and will probably complement and then replace the current segments. We appreciate this form, significantly cleaner than the previous structure, and better for communicating with investors where the successes (and losses) come from. Today the Institutional Client Group is responsible for a disproportionate amount of revenue compared to other segments, accounting for about 50% of the total.
To put these concerns into perspective, we want to analyze Citi on a comparative basis. This means choosing its most similar peers and performing a check on important metrics. Indeed, we believe that in the case of large bank stocks, they are all more or less exposed to the same systematic and idiosyncratic drivers of results. This means that choosing high quality names or those with the best risk reward is the best strategy. For Citi, we want to assess whether the current restructuring, along with the current valuation, offers an interesting risk-adjusted yield relative to others.
Comparables will be JPMorgan, Wells, Fargo, Bank of America and Santander. We included the latter to include geographic exposure other than North America as Citi is very diverse.
The first factor is dividends. Banks have experienced windfalls since mid-2022 as a result of rising rates, and now dividend yields are down to relatively generous levels. Citi has the highest yield among its peers, around 4.5%. This represents about a 150-200 bps premium compared to Wells Fargo, JPM and Bank of America. However, if we look at the ability to increase dividends over time, and thus increase its yield, we see that Citigroup is extremely slow and very bad. In the last 3 years, BAC and JPM grew by 8% and 4% respectively, while Citi remained well below 1%. The 5-year comparison is also poor.
To put things into perspective, that’s the difference between a growth rate of 0.65% and 4% over the long term. That is, Citi’s current dividend growth rate is either its own or JPMorgan’s.
While most of us certainly do not have a time frame that extends to 2060, it is useful to see the importance of growth, even in the short and medium term.
Now we focus on valuation metrics, especially P/E.
As we expected, Citi is again on the cheaper side of the spectrum. By inverting the ratio, we can derive the earnings yield. While JPM and BAC stand at 10.7% and 11% respectively, Citi is at 12.7%. Again we see a spread of under 300 bps, which means we are paid a premium of around 3% to buy a restructuring bank with a much more complex structure and a sub-optimal growth rate.
What can go well: the opposite scenario
While we have concerns about the ongoing restructuring and think the current valuation is not low enough, there is still some room for improvement. In particular, we identify two potential strengths that may benefit Citi shareholders more than comparables. The success of the streamlining efforts could really drive two major upsides: (1) margin expansion as costs are reduced with little impact on earnings, and (2) the market will re-evaluate Citi’s valuation multiples.
There is a kind of double reversal in case the current management is able to achieve all the objectives of the current plan. This is because not only will the bank benefit from lower compensation, compliance and administrative costs, but the market will also value it with higher valuations. So, in that scenario, investors should expect higher returns than other comparable publics.
Citigroup is once again going through a long and complex process to profoundly change its structure and improve efficiency. We believe we have heard this story many times and it should be taken with a grain of skepticism by shareholders. At the same time, we also think that other comparables offer better risk/reward opportunities as Citi’s valuation is not yet low enough. We remain on the lookout for developments on the business or valuation.