Tuesday, July 24, 2007

Citigroup Turnaround Progressing

Much like a large ocean liner turns slowly, Citigroup's (C) size determines that a turnaround at the banking giant will not be immediate. But, when you have consecutive quarters of year over year strong earnings growth for the fist time in recent memory, one must be encouraged.

International operations posted a 34% increase in earnings and "alternative investments " (read: hedge fund operations) saw a 77% increase. Citi has made a huge push internationally the past two years and those efforts are now paying off in a major way. In thew recent quarter they closed the acquisition of Egg in the UK (credit card and online banking businesses) and Grupo Cuscatlan (Central American banking). Deals for the Bank of Overseas Chinese and Taiwan, of Bisys and of ATD are all businesses that will expand operations in high growth markets. Also they closed Old Lane early this month and managers Vikram Pandit and John Haven that come with the have a value that cannot be quantified. Most significantly, they now own 60% of Nikko Cordial in Japan in a deal that puts them in the forefront in that region. Roughly 1/3 of the international units growth came from acquisitions meaning that Citi is consistently picking winners.

The big negative and the reason for jittery investors selling shares? Credit costs rose to $934 million in the quarter, including a $259 million rise in credit losses and a $465 million charge to increase loan loss reserves. The $465 million net charge compares to a net reserve release of $210 million in the prior-year period, the company said. Simply put, credit losses are expected to mount.... no kidding. Bank after bank so far has reported the same thing so this should be no surprise. What this news means is that for the first time during his reign, CEO Chuck Prince was able to manage the business to it's best quarter ever during a tough time. Since we are so worried about load losses, let's look closer at the same quarter last year. Last year Citi released $210 million from loss reserves that help earnings and this year added $465 to them. That is a cool $675 million swing to earnings or a additional 12% earnings from operations in 2007 over 2006 when these items are backed out. That is significant because it means that when US credit improves and yes it will, Citi is sitting pretty with it's international operations to really boost earnings.

The consumer unit experienced a 15% earnings decrease and again, this was not totally unexpected. It was pointed out that they are opening up new locations at a "very healthy clip" and this will negatively impact earnings for that segment until those locations are up and running.

Citi is also still cutting costs and said they were "less than halfway" through the $2.3 billion they anticipate saving this year through staff reductions and IT improvements. The reductions to date have finally lead to operations leverage improvements as witness by Q2's revenue increase of 20% vs cost increases of 16%.

Where does all this leave us? Citi finally seems to be being "managed" and is producing results. It will not happen overnight but I do not have a problem getting paid a rock solid 4.2% by them to wait. T think the street is waiting for confirmation of a turnaround and another strong quarter or two should do the trick and get shares that trade at only 12 times earnings running.


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