June 17, 1998
Stocks for Dad
To Dad from Dale
by Dale Wettlaufer (TMF Ralegh)
First Citizens Bancorporation of South Carolina
(OTC: FCBN)
1230 Main St.
Columbia, SC 29202
http://www.fcbsc.com
$377 as of June 15, 1998
Dear Dad,
Happy Father's Day. As has become the tradition since I began working at the Fool, you're getting no tangible presents from me for Father's Day. No John Deere tractor, no nice tie, no Great Big Bertha. Sorry about that, Dad. Once again, I'm sending you an investment idea for Father's Day.
This year we're going again with information on a financial services company. I hope you're still holding Capital One Financial <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: COF)") else Response.Write("(NYSE: COF)") end if %>, which was last year's idea. This year I want to tell you about First Citizens Bancorporation of South Carolina. I ran into this company in a sort of roundabout way, doing research on the Census Bureau's website. I was looking for states that are projected to experience higher-than-average population and income growth over the coming five to ten years, and South Carolina came out near the top of the list.
In fact, we've talked about this a little bit. The demographics of South Carolina are very interesting because the Carolinas are becoming a very attractive retirement destination in lieu of the increasingly expensive and overcrowded state of Florida. South Carolina offers retirees the choice of living in the mountains, midlands, and colonial seaside towns. Plus, there are tons of great golf courses outside of the traditional golf spots of Myrtle Beach and Hilton Head. In addition to the economic growth that will naturally result from population inflows, South Carolina is a business-friendly, low-tax, low-cost state (for more information, I recommend checking out www.carolinaliving.com). These are the background characteristics we look for when we're looking for a growth-oriented investment in banking.
First, Dad, this company trades "over the counter," which at first glance breaks the Fool's rule against buying OTC stocks. We instituted that rule because pink sheet-traded stocks can be very low-quality companies subject to manipulated trading. However, there are a number of high-quality bank stocks that are traded over the counter because their owners desire the liquidity of being a publicly traded company without the reporting constraints of being a NYSE or Nasdaq stock. While a company traded through the pink sheets doesn't have to file 10-Q quarterly filings, First Citizens does, so you can track what is going on with the company. Also, its trading status works to our advantage because there's really no liquidity for institutions to buy the stock without upsetting the market. Despite this, I've purchased odd lots of shares without a problem. This isn't the sort of stock that you can get out of quickly, though. So if you're not a long-term investor in the company, you could have problems dealing with the trading.
With that important note out of the way, let's look at what kind of company we have here. First, this is a very conservative bank in many ways. The accounting of the company understates profits, the reserves for loan losses are much higher than average, and its loans-to-deposits ratio -- a key measure of leverage -- is much lower than the industry's average leverage. Let's look at some of the company's leverage and credit quality numbers.
Industry average First Citizens
Loans-to-deposits 101% 76.03%
Average Tangible Equity/
Average Tangible Assets 5.68% 6.32%
Loan Loss Reserves-
to Nonperforming Loans 364% 963.2%
Nonperforming assets/
Gross loans 0.86% 0.22%
So far, we're looking at a company that is better reserved, is less leveraged than other $2 billion+ banks, and has much better reserves. Because the economy in South Carolina is running with an unemployment rate below 3% and because the company has a high percentage of its assets in short-term government securities, its nonperforming assets ratio is very low. If loan losses were to pick up, that would hurt profitability as it would at any bank, but the company is so well reserved that it wouldn't have to play catch up and possibly do damage to the income statement.
Despite the company's conservative level of leverage, it still generates a favorable return on assets and equity. Taking amortization of goodwill out of the expense base, the company's trailing return on equity (ROE) is 19.2%, meaning the company is handily beating its cost of equity and is generating excess returns for shareholders. That compares with an industry average of 17.3%. On a return on assets (ROA) basis, the company's 1.36% compares quite favorably with the industry average of 1.27%. Further, First Citizens does not pay a dividend on common stock. As much as possible, its expansion is being funded with internally generated capital rather than borrowings. The shareholder doesn't get hit with a double-taxation of earnings when paid out as dividends. You don't need that many income producing stocks just yet, Dad.
Speaking of financing, the company just did a $50 million financing with trust preferred securities, which I expect it will use for further expansion. Last year, the company bought other institutions to the tune of $82.8 million while it generated net cash from operations of $40.4 million. Sources of funding last year included a 13.2% increase in deposits, to $1.88 billion, and a net increase in long-term debt of $4.48 million.
Finally, on valuation, there are few bank stocks of this quality (or, really, of any quality) that are trading at this level. Some valuation statistics for your perusal:
Share Price.....$380 Market Cap.....$353.1 million Price/Book.....2.12 Price/Tangible Book.....2.37 Price/Assets.....15.22% Price/Deposits.....18.67% Price/Revenues.....3.10 Amortization-Adjusted P/E.....12.1 (Cash EPS $31.39)
The liquidity in the stock is one reason it trades at a low multiple (part of the long-term investing thesis here is that the company will eventually get to a size that institutions can trade). Another reason is due to the company's conservative goodwill amortization schedule. I estimate that it is expensing its goodwill at a rate of 5 years versus an industry average of 15-20 years. That weighs down the income statement but doesn't make a difference to cash flow, as you know from your experience as a bank director.
I've got more information if you'd like it, Dad. Have a great Father's Day.
Love,
Dale
* A Stock for dad represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.