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Farmers & Merchants Bancorp: A Small But Growing Dividend King

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The Dividend Kings consist of companies that have raised their dividends for at least fifty years in a row. Many of the companies have turned into huge multinational corporations over the decades, but not all of them. You can see the full list of all 25 Dividend Kings here.

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Farmers & Merchants Bancorp (FMCB), which has raised its dividend for 52 years in a row, has remained a relatively small company, trading at a market capitalization of just $528 million.

Despite its small size the company has many things going in its favor, and shareholders will likely see compelling returns going forward. The dividend yield is higher than the broad market’s yield, and there is a lot of room for more dividend increases down the road.

Business Overview

F&M Bank was founded in 1916, yet, despite being in business for more than a century, the company hasn’t expanded very much.

F&M Bank operates 25 branches across the Central Valley and East Bay areas in California. F&M Bank is a full service community bank, which means that it provides services such as checking accounts, lending, etc. for businesses as well as for individuals.

Despite operating just 25 branches F&M Bank’s asset base has grown quite a lot over the decades. F&M Bank’s $3.1 billion in assets and $300 million of book value mean that each branch has an average of $124 million in assets (and $12 million of book value).

F&M Bank is backed by the Federal Deposit Insurance Corporation (FDIC), thus customers of the bank don’t have to worry about the safety of their deposits.

Growth Prospects

There are several reasons why F&M Bank’s growth outlook is quite solid, the first one is the macro environment for banks.

Rising interest rates are a negative for companies that are heavily indebted, but a plus for banks and other companies with a high amount of assets that will return more money with interest rates being at a higher level.

In a rising rates environment banks are able to increase the interest rates they take from debtors at a faster pace than the interest rate they pay to lenders. The result is a rising net interest margin, which is a key component for earnings growth for banks.

F&M Bank has been able to grow its loan portfolio as well as its average interest rate during the last year. A 6.2 percent loan portfolio growth rate, combined with a 5.4 percent yield increase means that F&M Bank’s interest income grew by close to twelve percent during 2017. Interest rates are likely to continue rising over the next several  years. It is likely that F&M Bank’s interest income will continue to grow.

The loans portfolio should continue to grow as well. California, where F&M Bank is operating, has a steadily growing population. California is the most populous US state; and it is still growing. Its population grew by 2.3 million during the 2010 to 2016 time frame alone.

This means that the amount of potential customers for F&M Bank is steadily growing, which should be a long term positive for F&M Bank.

The interest rate increases and solid economic conditions will be positives for all banks. F&M Bank will additionally benefit from its focus on California, where a population growth will lead to strong business conditions for the bank. The growth outlook thus looks quite compelling for F&M Bank right now.

Competitive Advantages & Recession Performance

F&M Bank is not a big bank at all — the company’s market cap is just several hundred million dollars. The bank nevertheless has been a solid performer for a very long time, and it remained stable during the last financial crisis

F&M Bank’s net earnings declined minimally during the 2008-2009 recession, with profits dropping by about ten percent. That is a huge contrast to what other banks had to report during that time. Earnings-per-share during the Great Recession are below:

  • 2007 earnings-per-share of $28.05
  • 2008 earnings-per-share of $28.69 (2.3% increase)
  • 2009 earnings-per-share of $25.57 (11% decline)
  • 2010 earnings-per-share of $27.05 (5.8% increase)

Major banks suffered earnings declines of 80% or even more during the last financial crisis. F&M Bank, with its focus on community banking and not on more speculative, riskier businesses, has been a much safer investment during those troubled times.

Since F&M Bank hasn’t made any changes to its business model since then, it is highly likely that the bank would still perform well in any future financial crisis or recession — at least relative to other banks.

F&M Bank also has a very low beta of just 0.62. This means that share prices do not decline much in a market downturn, which makes F&M Bank a relatively stable, non-volatile holding.

Valuation & Expected Returns

Since F&M Bank is so small, many sites don’t offer any valuation metrics for the company’s stocks. We can, however, calculate those ourselves: Based on a share price of $645 and earnings per share of $42.80 during 2017 F&M Bank trades at almost exactly 15 times trailing earnings.

The major banks are all trading at a relatively similar valuation, after valuations expanded during 2016 and 2017. F&M Bank thus is valued relatively in line with other banks’ stock, despite being much smaller.

Total returns are comprised of share price gains and the dividends a stock pays. F&M Bank currently yields 2.1%, which is higher than the broad market’s dividend yield, but that is not a very high dividend yield at all. Due to the positive macro factors (e.g. rising interest rates) F&M Bank’s earnings should continue to grow going forward, which should result in share price gains down the road.

There are no analyst estimates for F&M Bank’s long term EPS growth rate, but during the last couple of years the bank’s EPS rose by 8.5% a year. If F&M Bank’s multiple doesn’t change going forward, and if the bank’s EPS continue to grow at that pace, total returns would be roughly 10% (8.5% share price growth plus 2.1% dividend yield).

If F&M Bank’s multiple declines, total returns would be lower. With an 8.5% EPS growth rate F&M Bank would return 6% each year if its PE ratio drops down to a 12 times multiple over the next five years.

Final Thoughts

To sum things up: It looks like F&M Bank should provide returns of six to ten percent a year going forward, as long as economic conditions remain stable. F&M Bank has been a low-risk investment in the past, especially relative to other, bigger, banks. Those have been much more volatile and were hit a lot harder during the last financial crisis. Thanks to a low payout ratio (~30%) and a solid growth outlook F&M Bank should be able to raise its dividend for many more years.

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Article by Sure Dividend

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