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QCR Holdings Is Undervalued And
Unappreciated
June 23, 2014 | About: QCRH +0%
Financial institutions have seen drastic regulatory changes and
record-low interest rates since the collapse of the U.S economy in
2008. In fact, the Fed is still buying $45 billion in bonds per month as
a way to keep rates low and stimulate the economy. As the economy
slowly recovers toward pre-crisis levels and the bond-buying program
ceases, interest rates should begin to increase to normal levels. Even
though most of the major banks predicted these rate increases, the
10-year Treasury rate still yields 2.6%, and the Fed has yet to
increase short-term rates. As these interest rates normalize and begin
to rise at a faster rate, how will banks be affected? I believe that this
recovery period has been far from a normal interest rate environment. Therefore, certain
high-quality banks become unappreciated and overlooked, creating opportunities for
investors. I believe that QCR Holdings (QCRH) is one of those high-quality banks, given its
incredibly cheap valuation and history in net income growth. I will explain why QCRH is
unappreciated and why from a valuation perspective this bank provides an opportunity for
capital appreciation.
Why the Stock is Unappreciated
QCRH is a multibank holding company headquartered in Moline, Illinois. It provides
consumer and commercial banking, trust services, and asset management services for the
Quad City, Cedar Rapids, and Rockford areas. Just as any traditional bank does, QCRH
accepts deposits from its customers and invests in loans, leases, and securities. Its
business model relies on net interest income, or the difference between interest income
and interest expense, and the quality of its services. QCRH's net interest income has been
quietly increasing since the crisis, and consequently the company's shareholders should be
rewarded.
Investors looking for value in the banking sector may not look closely at a bank this small.
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This makes perfect sense for several reasons. First, investors are relatively uninformed
about small companies compared to large companies. They likewise will prefer investing in
large companies directly or in small companies via small-cap ETFs as opposed to
investing in the small companies directly. Second, smaller companies are riskier than
larger companies. However, with greater risk comes greater reward. Regardless, QCRH is
a hidden gem, trading at a market cap of only $136 million. This is much smaller than its
close competitors, including First Midwest Bancorp Inc. (FMBI), trading at a market cap of
$1.3 billion, and U.S Bancorp (USB), trading at a market cap of $78.5 billion. QCRH's size
is part of the reason as to why it is relatively unknown.
Additionally, the stock's average daily volume is approximately 8,700 shares. At a current
share price of $17.18, this equates to roughly .11% of its market cap. Therefore, any
significant buy or sell order can influence the stock price, and even compared to
competitors of similar size, QCRH is underappreciated. Many small-cap banks have
significantly higher volumes relative compared to QCRH. They also tend to have a larger
percentage of their market cap trade daily. Consequently, this is yet another reason why
QCRH is unappreciated.
($17.18 per share * 8700 shares) / ($136 M) = .11%
Why the Stock is Undervalued
It is very astonishing to me that a bank stock performing very well since the financial crisis
can be so underappreciated. It would be a different story if the bank took a major hit during
the crisis, as almost all banks did, and simply failed to recover. Over the past 5 years,
earnings per share have increased by 57.7% per year. Especially considering that the
company recorded EPS of $ -0.46 per share in 2009, this is an astonishing
accomplishment. The bank is showing no signs of slowing down either, as Chairman
James Brownson notes in his annual letter to shareholders:
"Despite an unsettled backdrop of an uncertain economy and an ever-challenging
regulatory environment, our teams executed on our strategic initiatives for another
record year.
For 2013, our annual earnings were up 18% from the prior year. For the year ended
December 31, 2013, net income attributable to QCR Holdings Inc. was $14.9
million, resulting in diluted earnings per share of $2.08 after preferred stock
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dividends of $3.2 million. For the same period in 2012, we reported net income of
$12.6 million, or diluted earnings per share of $1.85 after preferred stock dividends
of $3.5 million."
Source: QCRH 2013 Annual Report
Net interest income grew by 7.5% per year since 2008 as loan growth and rising interest
rates helped create more business opportunities. I expect this trend to continue as the
improving economy creates more business and higher interest rates allow QCRH to lend at
more profitable rates.
It is also important to note that QCRH acquired Community National Bank in Cedar Falls,
Iowa, adding almost $280 million in assets and $1.8 million in purchase gains. QCRH
incorporated this acquired business into its current Cedar Rapids entity, which should
improve the entity's efficiency and financial results. This illustrates a successful acquisition
that not only increased the bottom line but also reflected a smart strategic move by
company management.
Additionally, QCRH converted all of its "Series E" preferred stock into common stock,
which is consistent with the company's long-term capital plan. It increased their tangible
common equity ratio by 100 basis points and eliminated preferred dividends on the
balance sheet.
Now let's take a look at the company's valuation metrics. The following chart illustrates just
how much of a bargain QCRH is trading for (Source).
As the green bars illustrate, QCRH is extremely undervalued in every category relative to
both its industry and its own history. Despite QCRH's outstanding earnings growth during
the past five years, the valuations simply have not taken this into account. Given that
earnings have grown at a much faster pace than the banking industry as a whole and the
company's close competitors, a more appropriate valuation would be closer if not higher
than the industry average. Although depressed valuations may signal a bleak future in
earnings growth, I believe that this is not the case. As the economy strengthens, the
demand for loans will increase, and QCRH will be able to lend at higher rates, increasing
net interest income and hence profitability. Simply put, the potential for QCRH's loan growth
and rising interest rates should equate to a valuation more in line with the industry average.
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The following chart compares QCRH to some of its peers and the U.S Regional Bank
industry. Clearly, QCRH separates itself from everyone else.
P/E (ttm) P/B 5 Year EPS Growth
QCRH 8.60 1.00 57.70%
CBSH 16.90 1.90 7.90%
WTBA 14.50 1.90 16.80%
U.S Regional Bank Industry 15.7 1.23 8.30%
Take West Bancorp (WTBA) as an example. It has grown its earnings at a double-digit
pace during the past five years. It is appropriately valued to its growth, trading at a slight
discount to the industry average. QCRH, on the other hand, is trading at a significant
discount of nearly 55% compared to its industry but has been growing at a significantly
faster pace. Should investors treat QCRH the same as its peers, there is large amounts of
potential upside. In fact, an appropriate valuation at the industry average would equate to a
price of $31, representing over 80% upside. Although QCRH certainly may not realize this
potential upside, it is certainly trading at a bargain right now. Additionally, QCRH is trading
at a bargain relative to its own history. Its valuation metrics were much more expensive
before the crisis hit. At one point, its P/E ratio was 66 and its P/B ratio was more than twice
what it is now.
Further, insiders have increased their ownership from 5% to 8% in during the past few
years. This properly aligns the incentives of the insiders because they are betting their own
money on their own company. This is a bullish sign for investors considering a purchase in
the company's shares. Insiders clearly have the best perspective on the future of the
company and its future stock performance. The following chart illustrates insider
transactions over the past six months and over the past year. The first column shows the
number of buy and sell transactions during each time frame. The second column shows the
number of shares purchased and sold. Clearly, insiders are buying more shares than they
are selling, and this is a very good sign for prospective investors.
I expect that QCRH will increase in value over the next several years given its cheap
valuation and future growth prospects. The company's size is growing very rapidly, and this
should attract more attention from large investors. As the company grows, the apparent
mispricing between the current price and intrinsic value should become more apparent.
Comparisons to the company's industry and history both illustrate this mispricing.
Risks and Concerns
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Before making any investment, all investors should conduct their own proper, independent
due diligence.
QCRH faces several risks that should be taken into consideration. First, although it is
growing quickly, the company is still relatively small compared to most regional banks. A
lack of growth will keep this company off investors' radar, which would prevent it from
realizing its intrinsic value. Second, QCRH relies on rising interest rates to keep growing its
net interest income. This will become a problem if rates stay unexpectedly low. Although the
Fed recently announced that it would lower its monthly bond-buying program by $10 billion,
it does not forecast short-term interest rates to increase significantly until 2015 or 2016.
However, it is important to note that QCRH has been able to increase net interest income
during this low-rate environment.
Third, QCRH's financial strength is mediocre. Its interest coverage ratio is at the industry's
median of 1.1. This means that the company is able to cover its interest payments slightly
more than once. I would like to see QCRH management increase this ratio to at least 2 or
3. Its Total Equity/Total Assets ratio currently stands at 6% compared to the industry
average of 9%. According to Gurufocus.com, this ratio is higher than only 51% of the
companies in its industry. However, management is aware of this problem and is making
efforts to improve its financial strength. The following excerpt comes from the company's
2013 annual report:
"We remain committed to a strong capital position - not only with regard to total
capital, but with regard to mix and cost as well. We remain strongly committed to
our long-term capital plan of self-generating the capital necessary to grow tangible
common equity to a target range of 6.00% to 7.00%.
Tangible common equity grew from 3.56% of total tangible assets at December 31,
2010 to 3.85% at December 31, 2011 to 4.02% at December 31, 2012 and to
4.71% at December 31, 2013."
QCRH still has room for improving its financial strength, but it is a very good sign to know
that management is aware of the problem and committed to reaching set goals. This
illustrates to me that company management has outstanding leadership capabilities.
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Comments
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Final Thoughts
The U.S economy is slowing returning to a period of normal interest rates. The Fed is
slowly winding down its bond-buying program, which should increase rates in the next few
years. Many banks predicted a Treasury 10-year yield of over 4% by the end of 2014. This
may not happen, but I expect rates to increase significantly by the end of 2015. Also note
that the Fed will begin to increase short-term rates either in 2015 or 2016.
QCRH is in a great position to take advantage of rising rates because business activity
and lending rates will increase. This will increase net interest income and ultimately the
bottom line. QCRH is trading at a significant bargain, and as the company continues to
grow, I expect the mispricing between the current price and intrinsic value to narrow. By the
end of 2015, I see potential upside of nearly 50%.
Rating: 5.0/5 (1 vote)
Voters: