Home Fixed interest Ames National: High dividend yield, positive earnings outlook for next year (NASDAQ: ATLO)

Ames National: High dividend yield, positive earnings outlook for next year (NASDAQ: ATLO)

0

JonGorr/iStock via Getty Images

Benefit of Ames National Corporation (NASDAQ:ATLO) will most likely decline this year before rising next year. The normalization of loan loss provisions in a high inflation environment will likely hurt earnings this year. On the other hand, low to medium-bachelor single-digit loan growth will support earnings. In addition, the margin will likely improve next year due to this year’s interest rate increases. Overall, I expect Ames National to report earnings of $2.04 per share for 2022, down 22% from last year. For 2023, I expect earnings to rise 11% to $2.26 per share. The company offers a fairly attractive dividend yield. Based on the expected total return, I adopt a Buy rating on Ames National Corporation.

Weak loan growth should improve in the year ahead

Similar to last year, Ames National Corporation’s loan growth has been quite disappointing so far this year. The loan portfolio grew by only 0.9% in the second quarter of 2022 after a decline of 1.2% in the first quarter of the year.

Loan growth is expected to improve in the coming quarters thanks to economic factors. Ames National owns several banks that operate primarily in Iowa. These bank subsidiaries mainly focus on residential, agricultural and commercial real estate loans. Therefore, commodity prices for corn and soybeans, Iowa’s two major agricultural commodities, are a good indicator of market strength and appetite for credit.

Chart
U.S. Corn Farm Price Received given by Y-Charts

The unemployment rate as the state is among the lowest in the country, which also bodes well for loan growth. Additionally, the coincident index shows that the state’s economy is in good shape.

Chart
Iowa unemployment rate given by Y-Charts

Given these factors, I expect the loan portfolio to grow by 1% each quarter through the end of 2023 (4% annualized). Additionally, I expect other earning assets and deposits to grow mostly in line with loans.

Portfolio of securities to limit sensitivity to Topline rates

As mentioned in the last 10-K filing, Ames National is more sensitive to the revaluation of its interest-bearing liabilities than its short-term interest-bearing assets. One of the reasons for this price mismatch is that Ames National has a very large portfolio of investment securities that is primarily based on fixed rates. At the end of June 2022, the portfolio of available-for-sale securities represented 41% of total earning assets, according to details given in the 10-Q filing.

In addition, the deposit book is rapidly being revalued, as interest-bearing checking, savings and money market accounts accounted for 69% of total deposits at the end of June.

Given these factors, I expect the net interest margin to remain virtually unchanged for the remainder of the year despite rising rates. As most deposit repricing will be completed this year, while loan repricing will continue, I expect the margin to increase by 16 basis points next year.

Decline in profits due to the normalization of provisions

After recording significant provision reversals in 2021, Ames National continued to record net provision reversals in the first half of 2022. I expect the expected loan loss provisioning to return to the historical average in second half of 2022, partly because I’m expecting higher loan growth in the coming quarters.

Additionally, the existing loan portfolio will likely require additional provisioning as current coverage appears insufficient given the high inflation environment. As noted in Filing 10-Q, the Company’s level of problem loans as a percentage of total loans at the end of June 2022 was 1.00%, which is higher than the Iowa State Average peer group of institutions insured by the FDIC as of March 31. 2022, by 0.46% (most recent available). Compared to the problem loan ratio of 1.0%, provisions were only slightly higher at 1.4% of total loans.

Overall, I expect the net provision charge to be 0.13% of total loans (annualized) for each quarter through the end of 2023, which is the same as the 2017 average to 2019. Provision normalization will play a key role in driving down earnings this year. In addition, non-interest expenses will be higher this year due to the effect of inflation on payroll expenses.

On the other hand, loan growth will likely support earnings through the end of 2023. Additionally, expected margin expansion will improve bottom line next year. Overall, I expect Ames National to report earnings of $2.04 per share in 2022, down 22% year over year. For 2023, I expect earnings to rise 11% to $2.26 per share. The following table shows my income statement estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
income statement
Net interest income 42 45 55 56 54 58
Allowance for loan losses 1 1 6 (1) 1 2
Non-interest income 8 9 11 11 ten ten
Non-interest charges 28 32 37 37 39 40
Net income – Common Sh. 17 17 19 24 19 20
BPA – Diluted ($) 1.83 1.86 2.06 2.62 2.04 2.26

Source: SEC filings, earnings releases, author’s estimates

(In millions of dollars, unless otherwise indicated)

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with inflation and, therefore, the timing and magnitude of interest rate increases. Also, a deeper or longer than expected recession may increase the expected loan loss provisioning beyond my estimates.

A large AFS portfolio will lead to equity erosion

Ames National’s book value fell to $17.50 at the end of June 2022, from $19.43 at the end of March 2022, as mentioned in the Press release. This decrease is mainly explained by the unrealized capital losses accumulated on the portfolio of fixed rate investment securities available for sale. As interest rates rose, the market value of these securities declined, resulting in unrealized losses. These losses reduced the carrying value of equity through other comprehensive income, instead of the income statement.

As I expect the fed funds rate to rise 150 basis points in the second half of 2022 (including the 75 basis point hike in July), losses are likely to increase further. On the other hand, retained earnings will increase the book value of equity. The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
Financial situation
Net loans 890 1,048 1,130 1,144 1,164 1,211
Net loan growth 15.4% 17.7% 7.8% 1.3% 1.7% 4.1%
Other productive assets 489 595 768 921 915 953
Deposits 1,221 1,493 1,716 1,878 1,965 2,045
Loans and sub-debts 55 47 40 43 40 42
Common equity 173 188 209 208 162 172
Book value per share ($) 18.6 20.3 22.9 22.8 17.8 19.0
Tangible BVPS ($) 17.2 18.6 21.2 21.2 16.2 17.4

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Attractive dividend yield with secure dividends

Due to expected earnings growth for 2023, I expect Ames National to increase its quarterly dividend per share by $0.01, resulting in a cash dividend payout of $1.12 per share for the whole year. This dividend estimate suggests a strong forward dividend yield of 5.1%. I am confident that the dividend payout for 2023 is secure due to the following two factors.

1. Dividend and earnings estimates for 2023 suggest a payout ratio of 49.6%, which is close to the past five-year average of 52.2%.

2. There is no pressure to pay dividends due to regulatory capital adequacy requirements. Ames National announced a total capital ratio of 14.7% for the end of June 2022, which is well above the minimum regulatory requirement of 10.5%.

A moderately high expected total return warrants a buy rating

I use historical price/accounting tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Ames National Corporation. The stock has traded at an average P/TB ratio of 1.32 in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
T. Book value per share ($) 17.2 18.6 21.2 21.2
Average market price ($) 28.6 27.1 21.2 24.3
Historical P/TB 1.66x 1.46x 1.00x 1.15x 1.32x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $16.2 yields a target price of $21.4 for the end of 2022. This price target implies a decline of 3.6% compared to the closing price on September 9. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.12x 1.22x 1.32x 1.42x 1.52x
TBVPS – Dec 2022 ($) 16.2 16.2 16.2 16.2 16.2
Target price ($) 18.1 19.8 21.4 23.0 24.6
Market price ($) 22.2 22.2 22.2 22.2 22.2
Up/(down) (18.2)% (10.9)% (3.6)% 3.7% 11.0%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 12.4x in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
Earnings per share ($) 1.83 1.86 2.06 2.62
Average market price ($) 28.6 27.1 21.2 24.3
Historical PER 15.6x 14.6x 10.3x 9.3x 12.4x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $2.04 yields a price target of $25.4 for the end of 2022. This price target implies a 14.6% upside from at the September 9 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 10.4x 11.4x 12.4x 13.4x 14.4x
EPS 2022 ($) 2.04 2.04 2.04 2.04 2.04
Target price ($) 21.3 23.4 25.4 27.5 29.5
Market price ($) 22.2 22.2 22.2 22.2 22.2
Up/(down) (3.8)% 5.4% 14.6% 23.9% 33.1%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $23.4, which implies an increase of 5.5% compared to the current market price. Adding the forward dividend yield gives an expected total return of 10.6%. Therefore, I adopt a buy rating on Ames National Corporation.