Analysis: C

Monday morning before the opening bell, Citigroup (C) reported mixed headline results with its fourth quarter 2018 earnings. Revenue of $17.124 billion (down 2% year over year) fell short of the consensus of $17.515 billion, however, earnings per share of $1.61 (up 26% year over year) topped the consensus of $1.55. For the full year 2018, Citi's return on equity was 9.4%, and the return on tangible common equity was 10.9% (ahead of management's target of 10.5%), both representing key improvements over 2017's full year results.

By segment, Global Consumer Banking (GCB) revenue was $8.44 billion (consensus about $8.6 billion), flat year over year. Institutional Clients Group (ICG) revenue fell 1% year over year to $8.241 billion (consensus about $8.4 billion). Corporate/Other declined 37% to $470 million as the company continued its wind down of legacy assets.

In GCB North America, revenue increased 1% year over year to $5.254 billion. Digging further, Retail Banking revenue of $1.3 billion decreased 1%. Excluding mortgage, Retail banking revenues increased 5% on continued growth in deposit spreads, partially offset by lower deposit volumes. Citi-Branded Cards revenue was unchanged at $2.2 billion as growth in interest-earning balances was offset by the impact of the Hilton portfolio sale, amongst other previously disclosed partnership terms. Meanwhile, Citi Retail Services revenues of $1.7 billion grew 6%, primarily reflecting organic loan growth and the benefit of the L.L. Bean portfolio acquisition.

Outside the U.S, Latin America GCB revenue was flat year over year at $1.362 billion. In constant dollars, revenues increased 5%, or 7% excluding revenues associated with an asset management business in Mexico that was sold in the previous quarter. On this basis, retail banking revenues increased 6% while cards revenue grew 8%. Meanwhile, Asia GCB revenue declined 4% year over year to $1.824 billion. In constant dollars, revenues increased 1% excluding a modest gain on the sale of a merchant acquiring business in the prior year period. On this basis, retail banking revenues fell 1%, while card revenue increased 3%, excluding the gain, driven by growth in loans and purchases sales.

Within ICG, Banking revenue of $5.1 billion increased 6% (including gain/loss on loan hedges). Treasury and Trade Solutions revenue increased 7% on a reported basis and 11% on constant dollars to $2.4 billion reflecting continued growth in transaction volumes and deposits, while Investment Banking revenues of $1.3 billion fell 1% year over year as strong growth in advisory was more than offset by a decline in underwriting fees (due to lower market activity). Private Bank revenues increased 3% to $797 million on growth in loans and investments, and improved deposit spreads. Lastly, Corporate Lending revenue of $559 million increased 9% (when excluding gain/loss on loan hedges), reflecting loan growth as well as lower hedging costs.

After a posting a strong third quarter 2018 result, Citi's trading operations (specifically in Fixed Income) was the main source of this quarter's total revenue shortfall. In total, Markets and Securities Services revenue declined 11% year over year to $3.1 billion as weakness in Fixed Income Markets ($1.9 billion, down 21% year over year) more than offset growth in Securities Services ($653 million, up 7% year over year) and Equity Markets ($668 million, up 18% year over year). While the Fixed Income number is a disappointment, we argue that was of no surprise to investors and should have been priced in to the stock because management guided for this at the beginning of December at the Goldman Sachs U.S. Financial Services Conference, which we discussed in our Daily Rundown that followed here. Although trading did not build off its third quarter momentum like management initially expected, CFO John Gerspach said today that trading conditions have improved in the first few days of Q1.

From a capital-allocation perspective, shareholder returns were alive and well as Citigroup returned $5.8 billion of capital to common shareholders during the fourth quarter and repurchased 74 million of common shares. For the full year 2018, Citigroup returned a total of $18.4 billion of capital and repurchased 212 million shares. This pushed Citigroup's 2018 payout ratio to 110%, but management still has plenty of excess reserves available to return.

Checking in on some other key metrics, Citigroup's book value per share increased by $2.17 sequentially to $75.05 (ahead of the $74.23 expectation), and the tangible book value per share increased by $1.88 sequentially to $63.79 (ahead of the $63.10 expectations). The Common Equity Tier 1 Capital ratio ticked up to 11.9%. In simplistic terms, we think the stock price of a financial should trade in the same direction as tangible book value and its Return on Tangible Common Equity/Common Equity Tier 1 Capital ratio.

Slightly below expectations of 2.73%, the net interest margin (NIM) came in at 2.71%, a tick higher than third quarter's 2.70% figure. Although the yield curve has significantly flattened year over year, the 2.71% figure is still an increase from the fourth quarter 2017's result of 2.65%. Lastly, Citigroup's efficiency ratio came in at 57.8%, which is a tick higher than the 57.7% consensus. For the full year 2018, Citigroup's efficiency ratio was 57.4%, an improvement from 2017's 58.3%.

Bottom line, we believe this was another solid quarter for the company because the trading downside should have been well reflected in the stock and there were no major problems disclosed that would otherwise justify a valuation below tangible book. After an initial down open, we are seeing the market better understand this as shares have since pushed higher. Though shares have disappointed over the past year, we see a few reasons to stay long this value stock. We are encouraged with the recent increased involvement by Activist firm ValueAct and see a few potential positives that can occur down the road. We would not be surprised to see them push for more durable revenue streams outside of trading, a shift that would make revenue less volatile and market depended. Further, we expect the activists to keep management accountable for their various performance targets, which if they hit in the future, a premium will build on tangible book value. While we wait for this to occur, we have a terrific capital return story that pays for our patience with management repurchasing stock hand over first (at a discount) and a dividend that yields 3%. We reiterate our ONE rating.