Equity Research on Citigroup April 2006

Citigroup

Recommendation Sector Perform Sector Overweight Price Target 52

Overview

At this time Citigroup is rated sector perform in the financial sector, which is rated Overweight. It is an attractive buy only to those seeking steady income strategies or S&P index performance. Without many company specific catalysts or risks and because of its large size, Citigroup is likely to produce returns near the S&P and a financial composite of its divisions. Other investors looking for financial sector exposure are advised to look at mid cap growth commercial banks or investment banks. Currently a financial conglomerate such as Citigroup captures neither of these attractive trends comparably.

Sector Analysis

Commercial Banking (54%)- Commercial banks have been under margin pressure in recent months as a result of the small lending spread due to a nearly flat yield curve. Those banks such as Commerce Bancorp that are growing through retail have been able to minimize the effects of a small lending spread. This is likely to be ending soon as the fed is likely to stop raising rate at either 5% or 5.25%. However, if fed funds increase more than 5.25%, this will be a strong negative. Commercial Banks have been rising despite the margin squeeze likely in anticipation of the end of fed tightening. This trend is likely to continue and is supported by the strong technical break out of the Philadelphia bank sector trust (BKX) to multi-year highs.

Investment Banking (Solomon Smith Barney) (30%)-Investment banks, in a market flush with cash, have been producing record earnings particularly from strong M&A and high trading volume. Nearly all investment banks are on 52 week highs and the banks of comparable size to Citigroup’s investment bank division (GS, MER, LEH, MS) are up approximately 50% from June lows with the exception of Morgan Stanley which is only up 30%. Multiple expansion has contributed to the rise in stock prices, which are currently compressed from historical averages. As investment banks are less affected by a flat yield curve and raising interest rates, so long as equities continue to perform well, they are likely to continue their out performance. While Citigroup’s investment bank has also had a very successful year and is the most attractive part of the company, the overall size of Citigroup makes it hard for the investment banking division to have a very large impact on valuation and particularly multiple expansion.

Company Specific

Citigroup is the second largest financial conglomerate in the world. It is historically undervalued on a PE basis, with a forward PE based on 2006 EPS estimates of 4.75 of 10.2 compared to a 14 PE over the last 5 years. Assuming a slight multiple expansion to 11 on the expectation of the end of fed rate increases by 5.25% gives a price target for the next 12 months is 52. Citigroup has a very high level of institutional investment at 65%, reflecting that there is a lot of smart money in Citigroup and the stock is rather efficiently priced. Thus even if Citigroup appears to be undervalued in the long term, it seems unlikely that it will generate outsized returns under current market conditions in the next year.