Farmer Mac's Q2 - Boring Wins Again, Shockingly Cheap

Summary

• Farmer Mac generated $2.40 in cash EPS and is well on its way to meeting my $9.15 estimate for this year.
• Despite the pandemic and fears about trouble on the farms, Farmer Mac had only one default during Q2.
• Loan growth this year-to-date is a healthy 8.5%.
• Despite Farmer Mac's consistently proven stability and growth, it is trading at only one-third of the market multiple.
• I believe the stock is worth double its current level. And don't forget the 4.6% dividend yield.

I've been writing recently about the magical thinking driving up tech stocks. Well, Farmer Mac (NYSE:AGM) is about the perfect anti-magic stock out there. And it delivered again with its second-quarter earnings report. I strongly recommend this stock as a very reasonable double from the current price.

First, a quick description for Farmer Mac newbies.

Farmer Mac is a relatively small company with a $750 million or so market cap. It makes mortgage loans to farmers and selected infrastructure loans to support rural communities. Critically, Farmer Mac is a government-sponsored enterprise, like Fannie Mae and Freddie Mac. Farmer Mac’s debt has the implicit support of the federal government, which means it has lower debt costs than its competitors. This benefit – a “moat” in modern investment parlance – shows up in the three key financial variables for a lending institution:

1. Extremely low loan losses. Farmer Mac’s chargeoff rate (loan losses as a percent of loans outstanding) averaged only 2 bp a year for the last two decades. This truly might be the lowest loss rate for any U.S. lender over that period. If you know of a lower chargeoff rate, please pass it along.
2. A stable interest margin. A lender takes interest rate risk, which evidences itself in swings in its interest margin. Farmer Mac uses some of the benefit of its cheap debt to carefully hedge against market interest rate swings. As a result, its interest margin is quite stable.
3. High leverage. Bank assets are typically about 10 times their capital level; the rest is borrowed, mostly from depositors. Farmer Mac’s leverage is 28 times, yet its regulators say that Farmer Mac has a material amount of excess capital. Farmer Mac can afford the leverage because of its low credit and interest rate risks.

The combination of ultra-low credit and interest rate risk and high leverage has generated a steady 17% growing near 10% a year.

Farmer Mac’s boring and awesome Q2

Here is a summary of Farmer Mac’s second-quarter cash earnings:

Source: Company financial report.

EPS was up 6% from last year, and the $4.60 in first-half earnings puts Farmer Mac well on its way to surpass the $9.15 in EPS I forecasted for this year. By the way, I calculate “cash” earnings by using actual chargeoffs instead of the loan loss provision.

Loan quality remains outstanding

Amid the current economic disruption, loan quality is the paramount issue for lenders. There certainly have been a lot of scare stories about farmers. For example, here’s a headline and quote from The Wall Street Journal from August 6, 2020:

“About 580 farmers filed for chapter 12 bankruptcy protection in the 12-month period ended June 30, according to federal data. That was 8% more than a year earlier, though bankruptcies slowed slightly in the first half of 2020 partly because of an infusion of federal aid and hurdles to filing during the pandemic, according to agricultural economists and attorneys.”

Sounds dangerous, no? But Farmer Mac had only one loan default during Q2, following none during Q1. And its delinquent loan rate was only 31 bp, well within its historic range. Why? Three reasons:

1. People like to eat. Food demand is steady. Farmer Mac said that the unemployment rate in rural areas is actually lower today than a year ago.
2. The federal government loves farmers. It expresses this fondness by paying subsidies whenever farming economics is upset by trade wars, pandemics, or other issues. Farmer Mac said that during Q2 farmers received $6.6 billion of COVID payments and $7.9 billion of loans. And another $24 billion of funds are available for further farm aid.
3. Farmer Mac maintains stringent underwriting standards.

One note of caution – Farmer Mac has now granted forbearance on $400 million of loans. That’s only 1.8% of its farm loans, and there appears no pattern in requests by geography or farm product. But it bears watching.

The interest margin remains stable

This chart says it all:

Sources: Company financial reports

Unlike the banks, the current ultra-low interest rates haven’t damaged Farmer Mac’s interest margin.

Loan growth remains solid

Farmer Mac’s loan growth so far in 2020 is 8.5% annualized. The company reorganized its marketing effort over the past year, adding resources as well. It has a new AgExpress lending program that shortens the borrowing process. As a result, management said that it has 50% more active sellers to them (they source most of their business through banks) than in 2019.

Now for the fun part – valuation

I’ve described a very stable company with growth approaching 10%. I’ll add that the dividend is $3.20 a share. Sounds like a stock that should be trading near the market multiple, right?

Very, very wrong, my friends. The S&P 500 is trading at nearly 21 times next year’s expected EPS, according to data from Yardeni Research. Farmer Mac? Seven times my 2021 forecast of $10.00 EPS! One-third of the market multiple. That must mean that Farmer Mac’s EPS growth has been significantly lagging the S&P 500, right? Wrong, it has been beating the S&P 500:

Sources: Farmer Mac financial reports, Yardeni Research

I can only conclude that this is a serious error in judgement by investors. Farmer Mac is way too cheap. I believe a fair P/E is at least 15, which is certainly reasonable for a company with a steady 17% ROE, growth approaching 10%, and let’s not forget its moat, the implied government guarantee on its debt. That puts my target price at $135, nearly double the current price. With a 4.6% dividend yield to boot.

Disclosure: I am/we are long AGM. 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.