Berkshire Hathaway (BRK.A) (BRK.B) disclosed a substantial first-quarter investment in Citigroup (C) of 55 million shares, a 2.8% stake. Since the 2009 government-assisted recovery from the financial meltdown in 2008, the shares of Citigroup have languished. Citigroup stock has been well-valued for years yet has frustrated various savvy value investors for a decade. The nod of approval from Berkshire could signal the shares are too cheap to ignore and it's finally the right time to buy Citigroup.
Citigroup has a strong banking franchise. However, various miscues have disheartened investors. The performance of the bank's management has been underwhelming, especially in regard to the underinvestment in technology to support risk and controls. Lately, recession fears affecting the financial sector and exposure to Russia and Ukraine of $8.8 billion have knocked Citigroup shares down about 20% this year. Citi has been divesting in areas exposed to Russia in addition to other international operations.
It's easy to see what attracted Berkshire: Citi's low forward price-to-earnings (P/E) multiple of 7, valuation 45% below book, strong cash flow, $15 billion in earnings directed to its stock buyback program and a generous 4.3% dividend yield. Citi returned $4 billion to shareholders in the first quarter by paying $1 billion in dividends and conducting $3 billion in share buybacks. Remarkably, at that buyback pace, Citigroup can reduce shares outstanding by more than 10% this year. In the past decade, Citigroup has reduced its shares outstanding from 3.03 billion in 2013 to 1.94 billion currently.
The market has focused on macro concerns and ignored the benefits banks will secure from interest rate increases. Yet, net interest income at Citi is expected to increase by more than $2 billion in 2022 and an additional $3 billion in 2023.
Warren Buffett's conglomerate has shown a strong affinity for companies with hefty buybacks such as Apple (AAPL) and Bank of America (BAC) , its two largest holdings. Berkshire has been an investor in Bank of America since first buying stock and warrants in 2011 in the wake of the financial crisis at a time when the bank needed support after struggling with the acquisitions of Countrywide Financial and Merrill Lynch. Berkshire now owns more than a 10% stake in Bank of America as steady buybacks during the past decade have reduced shares outstanding by more than 30%. It's reasonable to expect Berkshire to be a long-term holder of Citigroup as well, and perhaps increase its stake over time.
Citi's new CEO, Jane Fraser, has been cleaning up the bank's risk and control management, issues left by her predecessor. Citi paid $400 million to federal regulators last year after mistakenly wiring $900 million to a group of bondholders, exposing internal control lapses. The Office of Comptroller of the Currency called the bank's deficiencies a "longstanding failure to establish effective risk management."
Wall Street has given up on Citigroup's stock after it failed to perform in a 13-year bull market. Berkshire is the perfect investor to help the shares regain the Street's confidence and focus on its positive attributes and deep value. Buying shares around $50 delivers a solid yield and significant upside potential.
