Citizens Financial Upgrade To Strong Buy, Undervalued With 6.3% Dividend Yield (NYSE:CFG)

Research Summary

Today I’ll be doing my 3-month review of a stock I rated back in June, using an updated rating methodology and seeing if it earns an upgrade or not.

Citizens Financial (NYSE:CFG) continues to be on my watchlist of regional bank stocks, and since my last analysis on June 30th the share price had gone up for a while and then leveled off back down again, now at a net change of 0.00%, as you can see from the graphic below. That points to my bullish prediction being correct, in the short-term sense at least.

For readers new to this stock, here are a few relevant points for investors, from their website:

The company had its FY2023 Q2 earnings release on July 19th and I will use some of that data in this article.

Two key peers of this company, according to Seeking Alpha data, are Huntington Bancshares (HBAN) and Regions Financial (RF).

My rating methodology is to break down my holistic rating into 5 categories: dividends, valuation, share price, earnings growth, company financial strength.

If the stock wins in at least 3 of these categories, I’ll give it a neutral/hold rating, and winning at least 4 and it gets a buy rating.

Dividends

In this category, let’s look at the dividends this stock offers. We will use Seeking Alpha’s dividend data for this section.

As of the writing of this analysis, the forward dividend yield is 6.31%, with a payout of $0.42 per share on a quarterly basis, with a most recent ex date of Aug. 1st. This yield has not changed much since my earlier rating, and being that it is past 6% it certainly grabs attention.

When comparing to its sector average, this dividend yield is 60% above its sector average. Now, at first glance I could say this looks like a really attractive yield, because who wouldn’t want to earn over 6% on capital invested, right?

But caution should also be practiced as a yield that is a lot higher than its sector can also be indicative of a recent share price drop, pushing the yield up. In this case, since I am a dividend-oriented investor and look for “dividend quick picks” each week, I consider a high yield a positive point as long as the other fundamentals line up.

Next, I am looking for 10-year dividend growth for this stock, which in this case it has. As you can see in the chart below, since 2015 the stock has shown a positive growth trend in dividends, which I think is a sign of being able to return capital back to shareholders, despite being a smaller “regional” bank.

Additionally, I am looking for stability with dividend payouts, and this stock has shown regular dividend payment history lately without interruption, as well as a dividend increase during the period shown in the table below. Again, more signs of capital return to shareholders.

Based on the data, I would recommend this company in the category of dividends. However, not everyone is a dividend-focused investor, which I recognize, so in the next section we discuss valuation.

Valuation

Next, we will take a look at two key valuation metrics I use, from Seeking Alpha valuation data, and they are the forward P/E ratio and forward P/B ratio. These are used so I can see where the market is pricing this stock in relation to its earnings and book value.

This stock has a forward P/E ratio of 7.19, which is 24% below its sector average.

I think this is a reasonably valued stock in this metric, since I would be looking for a P/E somewhere in the range of 7 and 10x earnings.

In terms of price to book value, more good news it looks like! This stock’s forward P/B ratio is just 0.57, which is 42% below its sector average.

Again, this I would consider reasonably valued since I am looking for a valuation range of 0.5x book value to 1.5x book value, however with a preference for a valuation just below average.

My justification is that there are many banks in this sector, if you are comparing this stock with other banks, where you can get a valuation close to 1x book value or less. For example, Huntington Bank’s forward P/B ratio is just 0.89, while Regions Bank has a forward P/B of just 1.02. The “why” behind these low valuations in this sector is I think that the market is being cautious on the banking sector’s future earnings. However, this could also present a value-buying opportunity for the rest of us right now in this sector.

Based on the examples I gave, I would recommend this stock on the basis of valuation.

Share Price

In this section, we take a look at the current share price and whether it presents a value-buying opportunity right now, based on my portfolio goals.

My investing idea to test: buying 10 shares at the current share price, hold for 1 year, and achieve a 10% or better capital gain (unrealized). At the same time, I want to also test a capital loss scenario, and my loss limit is -10% unrealized loss, which I don’t want to exceed.

The price chart (as of the writing of this article) shows a share price of $25.99, compared to its 200-day simple moving average “SMA” of $32.49, over the last 1-year period. I use the 200-day SMA as it is a long-term trend indicator that smooths out the price trend nicely.

To test my capital gains & losses targets, I created the following spreadsheet. It projects the unrealized gains & losses if the future share price (in Sept. 2024) rises 10% above the current moving average as well as if it drops 10% below the moving average.

In the above investing simulation (since no actual shares were traded), I am projecting unrealized capital gains of 37.5% in the 1st scenario and 12.5% in the bottom scenario, so in both cases I am anticipating a capital gain in 1 year.

To simplify this idea, the following chart shows a “trading range” within +/- 10% in relation to the moving average, and shows the current share price well below the bottom of this range.

In this case, I would recommend the current buying price, on the basis of the above simulation and charts.

Since every investor has different profit goals and risk profiles, consider this simulator just a general framework to help think about this stock in a longer-term sense.

Earnings Growth

In this category, I examine the earnings trends over the last year, looking at both top-line and bottom-line results but also any relevant company commentary from the last earnings results.

In a bank the two key ways to make money are from interest income and non-interest income.

The last year in this sector has been all about Fed rate hikes, which have not come down yet, and so I would say it reflects in the interest income of banks like this one who benefits from higher rates.

Case in point: this bank’s net interest income has shown YoY growth, so even though their interest expense grew their interest revenue also grew and exceeded it. This to me is a positive sign for this bank.

In addition, I am looking at YoY non-interest income growth as well, which this bank has achieved too. One thing to mention here is that this also shows revenue diversification beyond just depending on interest-bearing assets, and being able to grow other business segments as well.

Next, you can see that both the total revenues and bottom line grew on a YoY basis, both of which I find to be positive points for this bank, particularly during a challenging period for this industry in the wake of a few prominent regional bank failures this spring in the US, and the takeover of Credit Suisse in Europe.

Considering that Citizens is essentially a regional bank, they ended up beating analyst earnings estimates for Q2 by $0.04.

One call-out I want to make in terms of earnings growth “potential” is this firm’s recent expansion in the northeast US market, as the graphic below shows, and 60K new retail customers. The bank in their q2 presentation goes on to mention the acquisition of 200 branches, 1MM customer accounts, and 1,350 business clients. In my opinion, for a regional bank it certainly is on a growth trajectory and so more clients means more potential fees and upselling of other products like loans, credit cards, etc., which are interest-earning for the bank.

Based on this evidence as whole, I would recommend in this category and anticipate continued positive performance in Q3 as well.

Company Financial Strength

In this category, I will discuss whether the overall company shows strong financial fundamentals beyond just things like dividends, valuation, earnings and share price, with a focus on the capital strength.

The first thing to call out is the CET1 ratio, which is typically a regulatory requirement and in this case this bank is well above the benchmark with a CET1 of 10.3%, but also being consistently above 9%. This is a positive point, I think.

In addition, the firm is in a position to return capital back to stockholders via dividends and share repurchases, as the following data from their quarterly presentation shows. I think this is further sign of financial strength:

Paid $205 million in common dividends to shareholders in 2Q23. Repurchased $256 million of common stock in 2Q23. Remaining Board-authorized capacity of $1.344 billion at June 30, 2023.

CEO Bruce van Saun also echoed the importance of focusing on financial strength and driving the strategy behind that, in this quarterly earnings commentary:

We were very focused on further strengthening our capital, liquidity and funding position and delivered impressive results. Our CET1 ratio improved to 10.3% while also buying back over $250MM in stock, we grew deposits by $5.5B, and we reduced our FHLB borrowings by almost $7B to $5B.

Also, when looking at the company balance sheet and cash flow statement, they point to more positive data points for this firm.

For example, with $223B in total assets and $199.5B in total liabilities, the firm is left with about $23.5B in positive equity.

I would also mention the importance of free cash flow per share, and this bank has a positive (FCF) for several quarters now.

Let me quote Corporate Finance Institute as they sum it up well as to the “why” behind why as analysts we even care about free cashflow:

FCF measures a company’s ability to produce what investors care most about: cash that’s available to be distributed in a discretionary way.

Based on the data overall, I recommend this stock in this category, and consider it a firm with solid fundamentals.

Rating Score

Today, this stock won in all 5 of my 5 rating categories, getting upgraded by me to a strong buy rating, compared to a buy rating I gave it in June.

My upgrade today is actually more bullish than the consensus from SA analysts and Wall Street, as well as more bullish than the quant system.

My Rating vs. Downside Risk

In my initial rating of this stock in June I touched upon the risk of exposure to commercial real estate assets, so this time around I will briefly mention another factor that could be a downside risk to my bullish outlook.

Given the current rate environment, and no sign of the Fed bringing rates down just yet, it can be a double-edged sword in that it can benefit the interest-bearing assets the bank holds and makes money from but also can increase funding costs when the bank borrows money or gets deposits from customers.

Turn your attention to the following graphic which shows deposit costs steadily increasing for this bank since 2Q22, correlating with the continuing rise of interest rates. To stay competitive, a bank needs to offer attractive rates to keep or lure in depositors, or that customer can take their capital elsewhere to a better rate.

This, however, increases funding costs for a bank. I think that many analysts and investors may be become bearish on this bank out of concern for its squeezing net-interest-margin (NIM), or may bearish on this sector overall and this stock gets swept under the rug along with its sector. I already touched upon the incredibly low valuation this stock is having.

My counterargument to any potential bearish sentiment is that the pressure on net interest margins will be a short-term challenge almost all banks face right now and not just this one, and I believe the market has already priced in this current reality.

The sentiment among rate traders according to CME FedWatch is that there is an 81% probability the Fed will hold steady on rates after their November meeting, and only a 32% chance they will raise rates after their December meeting. So I think we can expect elevated rates for the rest of FY23, as well as continued squeeze on margins, but then it will plateau and the positives I have presented for this bank far outweigh the squeeze on its margins and should offset any bearish sentiment.

My strong buy rating therefore stands.

Analysis Wrap-up

To wrap up today’s discussion, here are the key points we went over:

This stock got upgraded by me today to a strong buy, from its previous buy rating in June. My upgrade is more bullish than the analyst consensus.

Its positive points are: dividends, valuation, share price, earnings growth, company financial strength.

The downside risk of interest-rate risk has been discussed.

In closing, I am adding Citizens to my list of “dividend quick picks” for this week, and as I have shown it presents an interesting value opportunity among regional banks.