Introduction: The banking business is a difficult one. As with airlines, one bank sells a similar product as another one, either standard depository services to savers or a loan to borrowers. So, differentiation between banks relates to quality of management on an ongoing basis, unlike, say, the case with a company such as Apple Inc. (NASDAQ:AAPL) that benefits from its unique operating system and brand name even in periods where its leadership may not be as innovative as at other times; or Microsoft (NASDAQ:MSFT), with a monopoly/near-monopoly in businesses for both Word and Office.
Headquartered near Boston, a relatively small savings bank company (i.e., a thrift), Hingham Institution for Savings (NASDAQ:HIFS), has been an expanding company for the past decade and longer, with a fine growth path established while retaining superior lending standards. Total assets at year-end 2013 were $1.36 B; deposits were $941 MM, and stockholders' equity was $103 MM. At year-end, 49% of the total loan portfolio was invested in residential mortgages and 46% was invested in commercial real estate (including multi-family housing). The company is led by CEO Robert Gaughen, who has been CEO since 1993 and whose son Patrick is Senior V.P and may succeed him.
Hingham has previously been cited as the top thrift in the Northeast and second-highest-rated thrift in the country. It sailed through 2009 with record earnings and likely was quickly rejected by Federal regulators in the 2008-9 period when they were passing out TARP money to large numbers of community banks.
In a difficult time for many banking and other companies regarding both the top and bottom lines, Hingham has now reported its Q1 results. In conjunction with recent liquidation of the stock based on no news at all, the stock now appears very interesting to me, and I intend to try to acquire additional shares Monday morning (i.e. after you have read this).
Discussion: Reading Hingham's shareholder material is like reading that of a mega-bank, minus three zeroes. Thus, when it mentions $130,000 in write-offs, it means it, whereas a BofA would mean $130,000 times one thousand (an arbitrary example). This translates to investors in an illiquid stock that is suitable in my view only for long-term-oriented, buy-and-hold investors. There are only 2.13 million shares outstanding, about 45% of which are closely held by the controlling Gaughen family and other insiders. When I began following and buying HIFS three years ago, it was a micro-cap. Some days it would trade no shares at all. Now, it always trades something, but often less than 1000 shares trade in a day; bid-asked spreads are usually wide; the algos do not appear to be very active here. So this is an old-fashioned stock not meant for trading but rather for collection of dividends and patient owners waiting for growth and inflation to bring asset values up sustainably.
The reason to be interested in joining us Hingham investors is because it is a well-run, expanding corporation with relatively low valuations in a relatively expensive stock and bond universe of securities. When Hingham goes on a growth spurt while it is relatively cheap, the stock can run fast, as its long-term chart shows:
Splits: Oct 6, 1998 [3:2]
The impressiveness of this is shown when comparing it to the S&P 500 stock index:
This seemingly prosaic company has actually been quite a growth engine. It has done this by having few loan losses and expanding its number of branches to eleven in measured steps. Its most recent expansion was to Nantucket Island last year, which appears to have gone very well. Before that, the company opened its second Boston branch, also successfully (Hingham itself is southwest of Boston). With a superb efficiency ratio around 43%, Hingham may be well-positioned to continue to add branches profitably and with meaningful EPS impact.
The company achieved record EPS for 2013 that were, however, only marginally superior to those for 2012, and the stock has sold off recently, perhaps fearing further difficult comparisons. However, business perked up last quarter, as we shall see.
Q1 results: On Friday, the company announced first quarter results, which were strong all around:
Excluding this event (an insurance recovery: Ed.), the Bank earned $3,636,000 or $1.71 per share (basic and diluted), representing a 13% increase in net income over last year...
Strong growth trends of recent years continued, as deposits increased by $133.5 million representing a 15% increase from March 31, 2013. Net loans increased by 18% and total assets increased by 17% as compared to March 31, 2013. Stockholders' equity increased $16.7 million from March 31, 2013 to March 31, 2014, representing a 17% increase, with a related increase in book value per share from $44.88 to $52.70. (Note: some of the increase in book value relates to the one-time insurance-related gain.)
Hingham has elected to be regulated by the FDIC, not the SEC, so conventional Web-based sources such as Yahoo! Finance do not provide links to its filings.
In any case, this is a company that is not a takeover candidate (or so it would appear), so valuation is key. On that regard, I will speculate a bit. I will take $70 as the current price for HIFS, but again warn that this stock is relatively illiquid. It might trade at $68 or $73 on the same day for no apparent reason, depending on what a given buyer and seller happen to agree on.
Valuing HIFS: Based on Q1 operating results and the apparent slow growth of the U.S. and Northeast economies, I am going to guesstimate $7 for Hingham's EPS this fiscal (and calendar) year, with a book value of $56+. I am going to peg its sustainable growth rate as being in the 7-10% range, with a reasonable chance that it can grow faster to that as it adds branches with high returns on invested capital.
Given its high-quality earnings and prudent lending history, and its lack of any need to have taken TARP bailout money, HIFS deserves a premium valuation, though with some offset for its stock's relative illiquidity.
Hingham has previously called itself a thrift. In Value Line, the thrifts have their own industry class. Companies with less attractive operating characteristics and earnings growth are receiving multiple in the 13-21X range. Thus I think it is conservative to value HIFS at 14-15X this year's expected earnings, or around $100 as fair value based on quasi-comparables. The stock is currently trading with what I estimate as about a 2% yield. Investors need to know that for some years, the company has paid out a fifth dividend, usually at year-end. I am assuming that a dividend increase is not far away, and that a fifth dividend is coming within the next year, to arrive at a guess of about $1.40 in next-12 month dividends.
Should the company wish to be taken over, it would in my view deserve a significant premium to book value. 2X book would strike me as too low. Even that low premium would value the stock at about $112 or more based on my projected year-end book value.
Based on standard valuation metrics, it is actually to come up with 17-18X as an intrinsic value for this stock, but standard formulae do not take into account the poor trading characteristics of this stock, so I would shy away from using them in this case.
Risks: Interest rate spreads may be declining again, and it could be that since there has been no recession since the Great Recession, another one could be "due." Both these possible events would work against Hingham and could lower its volume of business while diminishing the profitability of said lower volume. Of course, real estate values could decline again, which would impair the asset values against which Hingham has provided loans.
Many other risks are present, one of which is illiquidity of the stock. There are no options on this stock, so one cannot hedge against a price decline that way, either.
Summary: After a relatively flat 2013 and relatively flat Q4 in 2013 for earnings (with business growth offset by shrinking margins), Hingham has re-emerged with strong operating metrics as well as strong EPS growth. This company does not go out if its way to promote its stock, but as I see it, it does a fine job running its business. I am happy to be a passive shareholder and am looking to increase my stake in the stock, i.e. buy the dip, now that I see EPS growth is back on track and fundamental value metrics make the stock look undervalued. In a stock market that as a whole has high valuations, and where I have to go out over 5 years to receive a fixed bond coupon of merely 2% from the U.S. Treasury, I find the theorized 2% forward dividend yield from HIFS to be adequate compensation for my willingness to hold the shares. I look at HIFS as one of the stocks which I wish to hold for the very long term and where I am not even sure that a takeover offer would suit me, unless it were exceedingly generous.
If this special situation is of interest, you may also find the company willing to talk with you. Their investment relations personnel is not overwhelmed with calls. Again, please be aware that because liquidity is challenged for HIFS, limit orders are in my view advisable for anyone looking to trade this stock.
Disclosure: I am long HIFS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.