Farmers & Merchants Bancorp: Growing Bank To Consider

Sep. 23, 2022 6:10 AM ETFarmers & Merchants Bancorp, Inc. (FMAO)

Summary

  • We think you should be buying into regional banks into the weakness from the Fed, such as Farmers & Merchants Bancorp.
  • Rising rates are a benefit to banks, but the fear of economic collapse is leading to pain.
  • Growing loans and deposits organically and through acquisitions.
  • Yield approaching 3% which is a decent return while waiting for capital gains.
  • Looking for a helping hand in the market? Members of BAD BEAT Investing get exclusive ideas and guidance to navigate any climate. Learn More »

Shot of a young woman using a digital tablet while inspecting crops on a farm

Moyo Studio/E+ via Getty Images

To no one's surprise, this rising rate environment has wreaked havoc on the markets. It has gotten particularly bad the last two weeks. Banks were hit hard the last few months. We think investors should let the market sell off some more here in September and then do some buying. One such place we would like to see our members buying in would be the banks. Regional banks in particular look set up to do well over the next few years after the market adjusts to the actions taken to stymie inflation. We encourage our members and followers to put money into financials, and specifically regional banks on this weakness. A higher rate environment will help banks in 2023 and 2024, and one that we like on a pull back to under $25 is Farmers & Merchants Bancorp (NASDAQ:FMAO). Right now, the stock is pulling back slightly with a weak market the last two weeks, but the company has been doing well, despite a tough macro environment in 2022. When Farmers & Merchants reported Q2 earnings, they were impressive despite a tough macro situation in H1 2022. In addition, the bank pays a dividend that it just raised, and the yield will be over 3% at our preferred entry under $25. We think this dividend can be raised further next year as we move forward in a higher rate environment. Wait for a pullback, then buy. Let us discuss the key banking metrics we follow.

Q2 headline strength

The bank's operational results were mostly better than expected in Q2. Farmers & Merchants Bancorp saw revenues and earnings grow thanks to continued loan growth and deposit strength. The top line expanded from last year. The Q2 revenues were $21.9 million, rising 36.9% in this metric year-over-year, largely due to the completion of both the Perpetual Federal Savings Bank, Inc. and Ossian Financial Services, Inc. acquisitions. Still, organically, there was loan and deposit growth. It should be noted there will be more growth as the company is also purchasing People-s Sydney Financial as well.

Earnings were strong as well. While year-over-year revenues ripped higher due to new assets under management, margins were strong, which helped fuel earnings power. Due to strong top line and increases in margins, the bottom line was better than expected. Net income was solid at $8.3 million or $0.44 per share, beating consensus by $0.01. Earnings will now start to grow at a more organic normalized pace, especially as the company fully incorporates recent acquisitions and their operations. The bank has been a serial acquirer the last few years. We think 2023, especially H2 2023 will be even better based on the trends we are seeing for banks, especially in a rising rate environment, once we see peak recessionary pressures abate.

Book value suggests waiting for a dip

We think you get a better price before entering the stock. While the stock is not expensive relative to tangible book, we would like to see you buy shares at or below book value. Thus, investors should wait, in our opinion, though we are bullish long-term

FMAO stock is somewhat expensive at $27 relative to the tangible book value per share at June 30, 2022. Tangible book value per share was $17.43 as of this time. This tangible book value jumped from Q1 2022 and from the start of 2022. There is a strong pipeline of loans as well. Still, this is not an expensive stock on most financial metrics, but let it fall. It is very rare to find regional banks trading near tangible book. On this metric, valuation is a bit more stretched, but on a selloff, we are buyers.

Loans and deposit growth

As we always stress, growth in loans and deposits are a key metric that we follow. Naturally, with acquisitions, we expected a rise here. But growth on these metrics is key whether the bank is small or large. And this company is not very large numbers wise. The fact is that banks tend to do better when rates rise because the idea is that they should make more money on the margin between what they lend out and what they pay for funds. We are seeing signs of that now. The net interest margin for the quarter increased to 3.14%. Rising margins are a big plus for earnings potential. We want to own these stocks as margins widen. We know there is pressure from inflation and possible rising unemployment, which seems to be a Fed goal, but we suspect these stocks find a bottom soon. On top of the better margins, loans are growing, and not just because of acquisitions.

Total loans were a record of $2.035 billion and increased 9.6% from $1.857 billion at the start of the year. Total loans were up 39.5%, or $576.4 million vs. compared to $1.46 billion in Q2 2021. Excellent. Total deposits have grown, which we like, and they grew 20% to $2.675 billion. The bank has strong liquidity with which to lend out to future customers.

Farmers & Merchants Bancorp asset health

So growing assets is great, but you want to have a sense of the quality of assets. Farmers & Merchants maintained strong asset quality metrics in Q2 2022. The provisions for loan losses creeped up much like other banks in Q2 as the macro situation is so poor.

There was a provision of $1.63 million, rising from a year ago when they were $0.641 million. Non-performing loans improved dramatically as well. They were 0.28% in Q2 2022, improving from 0.48% of all loans a year ago, and 0.44% from Q1 2022. We will be closely watching for trends on this key metric. Net charge-offs are basically 0% of all loans, there was a small $26,000 charge off in Q2, and that is a win.

The bank has a strong efficiency ratio as well, at 50.17%. This led to a very strong return on equity of 11.6% in the quarter, vs 8.0% a year ago.

Overall, the asset health is strong.

Final thoughts here

We think that this is an interesting regional bank that has been on a shopping spree of acquisitions. The assets of recent purchases are now rolled in and almost fully integrated. We are seeing improving performance in the loan pipeline and in margins. We want to own regional bank stocks for 2023 growth. If the stock pulls back, so it is cheaper relative to book value, it would be an even better proposition, especially if you can acquire it when it is at a level that equates to a 3%-plus dividend yield. We believe this dividend will be raised in 2023, especially as interest rates are now set to fuel earnings growth.

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