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Chemical Financial Corporation Is A Value Buy

|About: Chemical Financial Corporation (CHFC)
Summary

Chemical Financial has lagged behind the market despite better revenue and earnings streams over most bank sectors proving this to be a value buy.

Chemical Financial Corporation will be booming in the next two years as markets begin to take into consideration fundamental value over hype.

With one of the safest balance sheets among the rest of the banks, Chemical Financial is best suited for a downturn in markets and provides the safest buy as well.

Investment Thesis

Though share prices may have fallen in the past couple years, CHFC or Chemical Financial Corporation is bound for a reversal in the long term with a potential of a 35 percent upside due to its consistent earnings and revenue growth year over year and its low risk balance sheet relative to both the market and other banks.

Intro

Chemical Financial Corporation is a holding company that provides its customers with checking accounts, savings accounts, commercial and residential lending, and consumer financing. It essentially carries out the basic functions of a normal bank but seems to be outperforming many of them in respect to the value it brings to its shareholders and consumers. I will first examine the current state of Chemical Financial and then move on to explain why and how it is better than its many competitors. 

Why is Chemical Financial Down

With the overall economy taking a hit in December 2018 many banks also faltered and share prices as a sector went down. With this downturn, Chemical Financial or CHFC's share price also took a dive from its high at around $58 all the way to $35. Since that time the price has managed to recover only partially and has lagged behind the market due to pressure on the bank sector from low rates.

Additionally, this bank has a market cap of around 3 billion dollars posing some risk to consumers who believe only investing in Mega-cap stocks is the way to be safer in a market. I believe that many investors are in this similar boat and will discuss later why something seeming to be so simple and logical as "the bigger the company the safer it is" could be a detriment to investors in a market downturn. 

In the coming weeks I don't believe the value of this company will go up much, but as time progresses in the coming years and as fundamentals start to play a bigger role in the economies instead of markets that are propped up by hype, banks like CHFC will outperform those that seem to be successful currently.

Fundamentals

If we first compare the P/E to the rest of the market as well as other banks we will see that CHFC is the lowest among the averages at a value of 10.8. Banks in general are also at a low of 12.7 with the whole overall market printing at 18. Sometimes a low P/E doesn't signal that a stock will prevail in the future but only indicates its value based on current earnings. Investors may be wondering, that maybe revenue and earnings in the past year, though they are good, may have not been increasing therefore leaving the stock to not be priced in as growing. But when looking at the data, it's remarkable how well revenue and earnings have been perfuming on a year to year basis.

The annual growth rate in earnings and revenue respectively in just the last year for CHFC even after the entire market took one of its worst hits since 2008 was an increase of 44% and 38.7% whereas the average bank increased as little as 1.4% and 3.2% with the market growing by 14.1% and 7.4%. But even the past 5 years of CHFC outperformed the market and banks with consistent growth of at least 20% year over year with an average of 33%. Surely enough the price did indicate this growth the past 5 years, but due to market conditions and increased risk investors decided to stay out of lower cap stocks to insure protection against market downturns. But investors such as these may be missing out on understanding how much cleaner CHFC's balance sheet is compared to the larger banks in being safer from any obstacles that it might face.

CHFC is probably one of the safest banks to invest in with long term assets amounting for over 95 percent of their total assets with under 5 percent in short term ones. Additionally CHFC's level of assets compared to its equity is relatively low with any liabilities mainly consisting of low risk sources of funding. If we compare this balance sheet to some of the best performing banks in the industry such as JP Morgan Chase, the percentage of debt CHFC is nearly half of JP Morgan whereas longterm assets consist of over 50 percent of JP Morgan in terms of ratio . Though the market may be fearing the wherewithal of a company with a smaller market cap compared to a bank like JP Morgan Chase and how it can fend of any emergencies, I see that a safer balance sheet with stronger earnings shows a company being overlooked by many investors and a great longterm buy.

Discounted Cash Flow Model

To determine the intrinsic value of the stock and prove to you why based on this discounted cash flow model CHFC is a value buy, I will walk through some steps that arrived to my calculation.

CHFC Data Sources

Data Point Source/Calculation Value
Valuation Model Excess Returns Model
Stable EPS Weighted future Return on Equity estimates from 5 analysts. = Stable Book Value * Return on Equity = $42.04 * 11.5% $4.83
Book Value of Equity per Share Weighted future Book Value estimates from 6 analysts. $42.04
Risk-Free Rate 10-Year US Govt Bond Rate 1.68%
Equity Risk Premium S&P Global 5.96%
Banks Unlevered Beta Simply Wall St/ S&P Global 0.6
Re-levered Beta = Unlevered beta (1 + (1- tax rate) (Debt/Equity)) = 0.602 (1 + (1- 21%) (101.09%)) 1.055
Discount Rate/ Cost of Equity = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium) = 1.68% + (1.055 * 5.96%) 7.97%

Excess Returns Calculation

Calculation Result
Excess Returns = (Stable Return on equity – Cost of equity) (Book Value of Equity per share) = (11.5% – 7.97%) * $42.04) $1.48
Terminal Value of Excess Returns = Excess Returns / (Cost of Equity - Expected Growth Rate) = $1.48 / (7.97% - 1.68%) $23.50
Value of Equity = Book Value per share + Terminal Value of Excess Returns = $42.04 + $23.50 $65.54
Current discount Discount to share price of $41.18 = -1 x ($42.04 - $65.54) / $65.54 35.85%

Based on the calculation is it evident that CHFC is below its future cashflow value by around 35 percent indicating even further that future stock prices should rise should fundamentals remain in tact.

Potential Downside Risk

With any bank stock during a time when rates are at an all time low and markets are beginning to feel the pressure of the china trade deal, it might seem weird to incest in CHFC. Additionally, analysts and many critics of the stock market are convinced that a market downfall is due to happen within the coming couple of years. It can be safely assumed that in both of these cases, CHFC will definitely take a hit with the market and either may become a better value play or go out of business - that for sure being the worst case.

The way I like to look at companies such as these is understand there history. CHFC has been around since 1917 with its IPO in 1988. This company was able to survive through both the dot com crash in 2000 and the housing crisis of 2008 with both cases dropping significantly less than other markets while recovering and succeeding both times after. The average drop in index funds like the S&P 500 were around 50 percent while CHFC on average dropped 33 percent during both those eras. Now the recovery from the index in 2008 to now versus CHFC was better but from the dot com crash to its all time high in 2007, CHFC by far takes the lead.

Now for the case that this bank may be too small to handle the pressures regarding profits and revenue I turn to again the great recessions of the 2000's era. Big banks are not always the safer bet. Take for example Bear Sterns. Now though this may be the example everyone knows of going bankrupt and falling nearly 40 percent in a single day; it just goes to show how something seemingly so safe can crumble in a matter of minutes. It generally all came to the level of debt the company was leveraging, how safe its assets were, and where it was being insured from. Comparing then vs now it is clear that the amount of lending being done without proper background checks was absurd but taking into account todays conditions as well as the management of CHFC, I believe it is one of the safest bets to make when trying for a longterm play.

Investment Strategy

Normally I would say this stock is a long term buy and hold, but with the upcoming risk of a potential recession, an options strategy play may be of value in my opinion. I believe that CHFC is a good buy at its current price of 42 dollars and for every 100 to 200 shares a put could be bought and held for the next six months in case rates continue to hinder banks as well as the china trade deal doesn't make it through to minimize any risk associated with current market situations. 

Conclusion

Overall at CHFC's current price of 42.04 is a bargain for what the stock should actually be trading at. At a value of 59 dollars (Its all time high), CHFC was generating less earnings and revenue but was just part of an overinflated market. Growth in the past year during the stocks worst performance in the past 5 years was exceptionally better than the preceding years and has grown year over year. Additionally, with an extremely safe balance sheet this stock is clearly undervalued. In the coming years I expect share prices to trend upward to its all time high and continue until the fundamentals of this company change.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CHFC over the next 72 hours.

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: This stock advice and analysis is the authors opinion and based on what he or she believes to be true. This does not mean the analysis and advice is true. This means that the author is NOT responsible for any investment decisions others make as they should decide on their own beliefs and options whether to follow someones advice or not.