The more I time I spend investigating the banks and thrifts that trade OTC, the more opportunities I find. There are many highly profitable, conservatively financed and growing banks and thrifts that trade at a single digit P/E and a fraction of book value.
One of these is Chesapeake Financial Shares, Inc. which operates Chesapeake Bank in coastal Eastern Virginia. Chesapeake also operates a wealth manage practice, a receivables factoring business and a merchant services business that processes card transactions. Chesapeake has been in operation for 112 years.
Loan Quality – Chesapeake’s loan book is solid. At year-end 2011, non-performing assets made up 2.67% of total assets, 43.3% lower than the national bank average of 4.71% calculated by the St. Louis Fed. The bank’s Texas ratio is very low at 10.9%. Chesapeake is mainly a small business lender, which tends to be riskier than traditional prime mortgage lending. However, Chesapeake’s loan book held up very well during the financial crisis, during which the bank remained consistently profitable.
Capital Ratios – Chesapeake has a 9.04% tangible common equity to assets ratio. The company’s risk-based capital ratio is 14.63%, well above the 10% the FDIC considers “well-capitalized.” High capitalization levels are not fool-proof; loan losses from bad underwriting will eventually eliminate the most well-capitalized bank’s reserves. However, high capital ratios provide a buffer from the normal economic cycle for banks with good loan books. On the other hand, high capital ratios limit profitability as well.
Profitability – Although Chesapeake is conservatively-capitalized, the is still highly profitable due to a large net interest margin and its other business activities. In 2011, the bank produced a return of average assets of 1.13% and a return on average equity of 15.31%. The company’s three year mean return on average equity is 14.00%, good enough for 16th in the nation among community banks and thrifts as reported by American Bank Magazine.
Consistency and Growth – Chesapeake’s public financial statements for years 1995 to Q2 2012 are available on the company’s website or from EDGAR. Chesapeake reported positive net income in every year during the period. From 1995 to the end of 2011, Chesapeake grew deposits at 9.98% per year. Earnings per share grew 9.44% annually and dividends per share grew at a 9.00% rate. Book value per share grew 8.40% annually even as the bank paid out 20% or so of earnings as dividends each year. The company’s recent growth rates have slowed, but that is to expected as the bank weathered one of the worst recessions in US history. For the twelve trailing months, Chesapeake produced record earnings of $2.24 per share and hiked its dividend to $0.44 annually. Book value per share now stands at $17.45.
Valuation – Despite its strong loan book, record earnings and continued growth, Chesapeake’s valuation is nothing short of depressed. At a mid-point of $14.30, Chesapeake has a trailing P/E ratio of 6.4 and a dividend yield of 3.1%. Price to book ratio is 0.82. Low price to book ratios are entirely justified for companies that do not earn their cost of equity, but Chesapeake certainly has it covered at a 15.31% return on equity.
I own shares in Chesapeake. With a 15.7% earnings yield, a discount to tangible book value and a history of growth and dividend increases, I don’t mind waiting around for the market to recognize the value of Chesapeake’s franchise.
Not related to this post, but thought you might be interested in REPR, an OTC heatlhcare stock. I am just digging in, but it seems they have growing revenue, positive cash flow and a product that might actually be making some in roads. There infusion pump is one of 2 approved for an immunoglobin drug that is offered by CHL a large Australian drug company. What I can’t figure out is what they are planning on doing going forward since they brought in a new CEO and new board, there aren’t a lot of press releases out there. After I read some more about the product, I will post back here if you are interested.
Very interesting! I have taken a look at REPR before and it seems reasonably valued. I was not aware of its growth potential. I’d definitely be interested in hearing what you have to say.
Interesting idea. Wondering if you have any thoughts with regard to how Dodd-Frank Act or Durbin Amendment might impact income, particularly the card fees. Also, how dependent is the local economy on military bases?
You make a good point about the possible impact of Dodd-Frank and Durbin on card fees. I am not an expert on the legislation. Can I ask your opinion on the effects of these bills? On the issue of military bases, I don’t think the company depends on military personnel for its deposit base. All of the company’s branches located on the rural coastal region of Virginia east of Richmond, an hour or more away from the Norfolk naval complex.
With regard to Dodd-Frank, my guess is that you’ll see it when it shows up in the income statement. For example, comparing the 1H2012 to 1H2011, the biggest thing that I see is an uptick in ATM expenses. Gross margins on Merchant Cards appear better, with income up and expenses down. Not sure why the Cash Flow program for financing A/R is listed as non-interest, as it appears to be listed as interest income in the quarterly Call reports. As with other small banks, they are making money flipping mortgages to the government. All these non-interest income sources boost ROA and ROE but are also more vulnerable to changes and thus bear monitoring.