Say Adios to Citi, Hello to the Morgans --- ZT from Barrons.

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CITIGROUP HAS JUMPED ALMOST 100% IN THE PAST month on huge trading volume that often tops a billion shares a day. But is there further upside in the stock, which is recovering from an historic collapse from more than $50 in 2007 to $1 earlier this year?

Answer: Near-term gains are apt to be limited. Investors should consider taking profits on shares (ticker: C) bought this year at prices below the current $5.22.

Barron's was bullish on beleaguered Citi a month ago, when the stock traded around $2.75, a fraction of its tangible book value. We viewed the company's strengths as underestimated and its ills as overstated. We argued that Citi could top $4 in the next year and ultimately hit $6.50 by 2011 or 2012 ("The Beauty of Banking's Big Ugly," July 27).

Citi isn't a bargain anymore. It now trades at a premium to estimated tangible book value of $4.35 a share, following an enormous $58 billion exchange offer in which preferred stock held by the government, public investors and a group of private investors was converted to common shares to bolster the big banking concern's balance sheet. That exchange offer ballooned Citigroup's total of outstanding common shares to 23 billion from five billion, permanently capping what it can earn per share. Citi shares are at or above most analysts' one-year price target.

Eventually, Citi should be able to earn about $15 billion, or 65 cents a share. If a price/earnings multiple of 10 is applied to those profits, the shares could hit $6.50, but that might not happen until 2011 or 2012. Citi now trades for eight times those "normalized" earnings. That is right in line with the price/earnings ratios of major banks and brokers on their estimated normalized profits.

JPMorgan Chase (JPM), at 43, is trading at 7.5 times Bernstein analyst John McDonald's estimate of normalized earnings of $5.70 a share. Goldman Sachs (GS), at 164, is fetching about eight times its recent annualized earnings of more than $20 a share, while Morgan Stanley (MS), at 29, is trading at 10 times projected 2010 profits of $3 a share. All three trade in a range of 1.4 to 1.8 times tangible book value, not a big premium to Citi.

JPMorgan is in better shape than Citi with stronger management, better profits and a lack of government ownership. It, like Goldman and some others, has repaid the money it received at the height of the financial crisis under Uncle Sam's Troubled Asset Relief Program (TARP).

But the federal ownership in Citi is 34% following the exchange of $25 billion of government TARP preferred for Citi common at $3.25 a share. The federal government, by the way, is showing a 60% paper profit on its Citi equity stake in just over a month, or $15 billion.

McDonald, whose price target for Citigroup is $4, has argued that JPMorgan boasts the "best mix of offensive and defensive characteristics among large banks." While Citi has been retrenching, diluting shareholders to boost capital and striving to return to profitability, JPMorgan has been expanding and gotten the government out of the picture with the repayment of $25 billion of TARP preferred.

Citi, in contrast, still has $27 billion of TARP preferred outstanding. Citigroup's market value of $120 billion is about as much as that of Morgan Stanley and Goldman Sachs combined.

Other negatives for Citi include the challenges that are inherent in its good bank/bad bank strategy. The bad bank, an internal entity called Citi Holdings, consists of a large group of consumer lending and other businesses with $649 billion of assets to be wound down or sold. Citi is seeking to exit a business as large as GE Capital -- no small undertaking. The good bank, using the Citicorp name, will consist of global retail and corporate banking businesses, as well as investment banking, with $1 trillion in total assets.

Citigroup also must work harder than rivals to keep and attract top talent, given the potential for bonus caps or unwelcome publicity, courtesy of the government's ownership stake.

Citi may be out of danger of collapse, but it still may not earn much until 2011, unlike its major competitors, which are expected to be solidly profitable next year. While cheap when it was below $3 a share, Citi looks fairly priced now. JPMorgan and Morgan Stanley look like better bets.
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2009-8-31 -04:00
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