Rating Update: Stock Rating C-Neutral (12/3/19)-Farmers & Merchants Bancorp Inc (FMAO).

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BUSINESS

Farmers & Merchants Bancorp, Inc. operates as the bank holding company for The Farmers & Merchants State Bank that provides commercial banking, retail banking, and other financial products and services to individuals and small businesses in northwest Ohio and northeast Indiana. The company offers checking accounts; savings and time deposits, including certificates of deposits; and custodial services for individual retirement accounts and health savings accounts. It also provides commercial, agricultural, and residential mortgage, as well as consumer and credit card lending products; loans for farm land, farm equipment, and livestock; operating loans for seeds, fertilizers, and feeds; home improvements loans; and loans for autos, trucks, recreational vehicles, and motorcycles.
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INVESTMENT RATING

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With future capital returns forecasted to exceed the cost of capital, FMAO is expected to continue to be a modest Value Builder.

FMAO has a current Value Trend Rating of C (Neutral).
This rating combines contradictory signals from two proprietary PTR measures of a stock’s attractiveness. FMAO has a slightly positive Appreciation Score of 63 but a slightly negative Power Rating of 36, and the Neutral Value Trend Rating results.

FMAO’s stock is selling well below targeted value. The current stock price of $25.82 compares to targeted value 12 months forward of $36.
This moderately high appreciation potential results in an appreciation score of 63 (only 37% of the universe has greater appreciation potential.)
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FMAO has a Power Rating of 36. (This slightly negative Power Rating indicates that FMAO’s chances of enjoying favorable investment performance over the near to intermediate term are only average.)
Factors contributing to this slightly negative Power Rating include: recent price action has been slightly unfavorable; and earnings estimate behavior for FMAO has been slightly negative recently. An offsetting factor is is currently in a modestly favorable positi.

INVESTMENT PROFILE

FMAO’s financial strength is exceptional. Financial strength rating is 98.
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Relative to the S&P 500 Composite, Farmers & Merchants Bancorp Inc has moderate Value characteristics; its appeal is likely to be to Income-oriented investors; the perception is that FMAO is extremely low risk. Low forecasted profitability is a relative weakness for FMAO. FMAO’s valuation is moderate: moderate dividend yield, moderate P/E ratio, and low price/book ratio. FMAO has unusually low market capitalization.

CURRENT SIGNALS

FMAO’s current operations are eroding. Return on equity is falling, reflecting: declining pretax margin; and falling leverage.

FMAO’s current technical position is very weak. The stock price is in a 14.2 month down move. The stock has declined 32.8% from its prior high. The stock price is below its 200 day moving average which is in a downtrend.

ALERTS

The stock is currently rated C.
Farmers & Merchants Bancorp Inc (NASDAQ: FMAO) stock enjoyed a major increase of 32.0% on 12/3/19. The shares closed at $0.08. However, trading volume in this advance was exceptionally low at 35% of normal. The stock has been weak relative to the market over the last nine months but is unchanged during the last week.

CASH FLOW

In 2018, FMAO generated a significant increase in cash of +$3.90 million (+10%). Sources of cash were larger than uses. Cash generated from 2018 EBITDA totalled +$28.61 million. Non-operating uses consumed -$8.19 million (-29% of EBITDA). Cash taxes consumed -$3.23 million (-11% of EBITDA). Withdrawal of investment from the business totalled +$4.82 million (+17% of EBITDA). On a net basis, debt investors withdrew -$12.31 million (-43% of EBITDA) while equity investors pulled out -$5.80 million (-20% of EBITDA).
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FMAO’s Non-operating Income, %EBITDA has exhibited little to no overall change over the period. This stability was accompanied by an uptrend for the Farmers & Merchants Bancorp Inc Peer Group. In most years, FMAO was in the second quartile and top quartile. Currently, FMAO is at the lower quartile at -29% of EBITDA (-$8.19 million).

FMAO’s Cash Taxes, %EBITDA has exhibited little to no overall change over the period. This stability was accompanied by stability for the Farmers & Merchants Bancorp Inc Peer Group as well. In most years, FMAO was in the top quartile. Currently, FMAO is upper quartile at -11% of EBITDA (-$3.23 million).

FMAO’s Business Re-investment, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Farmers & Merchants Bancorp Inc Peer Group. In most years, FMAO was in the top quartile. Currently, FMAO is upper quartile at +17% of EBITDA (+$4.82 million).

FMAO’s Debt Investors, %EBITDA has experienced a very strong overall downtrend over the period. This downtrend was accompanied by an opposite trend for the Farmers & Merchants Bancorp Inc Peer Group. In most years, FMAO was in the top quartile and lower quartile. Currently, FMAO is substantially below median at -43% of EBITDA (-$12.31 million).

FMAO’s Equity Investors, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by stability for the Farmers & Merchants Bancorp Inc Peer Group. In most years, FMAO was in the lower quartile. Currently, FMAO is slightly above median at -20% of EBITDA (-$5.80 million).

FMAO’s Change in Cash, %EBITDA has experienced a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Farmers & Merchants Bancorp Inc Peer Group. (Since 2016 Change in Cash, %EBITDA has experienced a very sharp decline.) In most years, FMAO was in the second quartile. Currently, FMAO is at median at +14% of EBITDA (+$3.90 million).
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FMAO’s Cash, %Revenue has suffered a volatile overall downtrend over the period. This downtrend was accompanied by a similar trend for the Farmers & Merchants Bancorp Inc Peer Group. (Since 2013 Cash, %Revenue has experienced a very sharp recovery.) In most years, FMAO was in the third quartile. Currently, FMAO is at median at +74%.

PROFITABILITY

FMAO’s return on equity has improved slightly since 2011.
This slight improvement was due to minor positive trend in pretax operating return and very small negative trend in non-operating factors.
The productivity of FMAO’s assets rose over the full period 2009-2019: asset turnover has exhibited a volatile overall uptrend.
Reinforcing this trend, pretax margin has exhibited a volatile overall uptrend although it experienced a very sharp decline after the 2017 high.
Non-operating factors (income taxes and financial leverage) had a very small negative influence on return on equity.
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FMAO’s return on equity is lower quartile (7.4%) for the four quarters ended September, 2019.
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Operating performance (pretax return on assets) is lower quartile (1.3%) reflecting asset turnover that is at the lower quartile (0.05X) and lower quartile pretax margin (27.9%).
Tax “keep” rate (income tax management) is at median (81.0%) resulting in after tax return on assets that is lower quartile.
Financial leverage (leverage) is lower quartile (6.93X).

GROWTH RATES

There are no significant differences between Farmers & Merchants Bancorp’s longer term growth and growth in recent years.
Farmers & Merchants Bancorp’s historical income statement growth has been in line with balance sheet growth. Revenue growth has paralleled asset growth; earnings growth has paralleled equity growth.

Annual revenue growth has been 4.8% per year.

Total asset growth has been 4.1% per year.

Annual E.P.S. growth has been 8.3% per year.

Equity growth has been 6.5% per year. (More recently it has been 13.7%.)
No consensus growth rate forecast is available for Farmers & Merchants Bancorp.
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Relative to the Farmers & Merchants Bancorp Inc Peer Group, FMAO’s historical growth measures are erratic. Revenue growth (4.8%) has been upper quartile. Total asset growth (4.1%) has been above median. E.P.S. growth (8.3%) has been at median. Equity growth (6.5%) has been below median.

Consensus growth forecast is unavailable.
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PRICE HISTORY

Over the full time period, Farmers & Merchants Bancorp’s stock price performance has been highly stable and quite good. Between April, 2013 and December, 2019, Farmers & Merchants Bancorp’s stock price rose +137%; relative to the market, this was a +23% gain. Significant price move during the period: 1) November, 2013 – July, 2018: +352%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -35.8% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through October, 2019 of -35.8% is lower quartile relative to Farmers & Merchants Bancorp Inc Peer Group.

Current 5-year total return performance of 16.2% is substantially above median relative to the S&P 500 Composite.
Through October, 2019, with substantially above median current 5-year total return of 16.2% relative to S&P 500 Composite, FMAO’s total return performance is above median relative to Farmers & Merchants Bancorp Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, FMAO’s overall valuation is quite low. The highest factor, the ratio of enterprise value/revenue, is slightly below median. Price/earnings ratio is below median. Ratio of enterprise value/earnings before interest and taxes is lower quartile. Price/equity ratio is lower quartile. The lowest factor, the ratio of enterprise value/assets, is lower quartile.
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FMAO has a large value gap compared to the median. For FMAO to hit median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 2.99X to 3.75X. If FMAO’s ratio of enterprise value/revenue were to rise to 3.75X, its stock price would be higher by $5 to $31.
For FMAO to achieve upper quartile valuation relative to the Farmers & Merchants Bancorp Inc Peer Group, its current ratio of enterprise value/revenue would have to rise from the current level of 2.99X to 4.78X. If FMAO’s ratio of enterprise value/revenue were to rise to 4.78X, its stock price would increase by $12 from the current level of $26.

VALUE TARGETS

With future capital returns forecasted to exceed the cost of capital, FMAO is expected to continue to be a modest Value Builder.
Farmers & Merchants Bancorp’s current Price Target of $36 represents a +41% change from the current price of $25.82.
This moderately high appreciation potential results in an appreciation score of 63 (only 37% of the universe has greater appreciation potential.)
With this moderately high Appreciation Score of 63, the moderately low Power Rating of 36 results in an Value Trend Rating of C.
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Farmers & Merchants Bancorp’s current Price Target is $36 (-19% from the 2018 Target of $45 but +41% from the 12/03/19 price of $25.82). This slight fall in the Target is the result of a +13% increase in the equity base and a -28% decrease in the price/equity multiple. The forecasted decline in return on equity has a very large negative impact on the price/equity multiple and the forecasted increase in cost of equity has a slight negative impact as well. Partially offsetting these Drivers, the forecasted increase in growth has a large positive impact.
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PTR’s return on equity forecast is 9.2% — slightly below our recent forecasts. Forecasted return on equity enjoyed a dramatic, variable increase between 2011 and 2018. The current forecast is above the 2013 low of 7%.

PTR’s growth forecast is 8.0% — slightly above our recent forecasts. Forecasted growth exhibited a slight, erratic decline between 2011 and 2018. The current forecast is well above the 2015 low of 2%.

PTR’s cost of equity forecast is 6.4% — in line with recent levels. Forecasted cost of equity exhibited a slight, erratic increase between 2011 and 2018. The current forecast is steady at the 2011 low of 5.7%.
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At Farmers & Merchants Bancorp’s current price of $25.82, investors are placing a negative value of $-6 on its future investments. This view is not supported by the company’s most recent performance that reflected a growth rate of 5.0% per year, and a return on equity of 12.2% versus a cost of equity of 6.2%.
PTR’s 2020 Price Target of $36 is based on these forecasts and reflects an estimated value of existing assets of $26 and a value of future investments of $10.

About John Lafferty 54938 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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