TPS Trade Alert – August 10, 2016

Recommendation:

Buy Central Federal Corporation (NASD: CFBK) up to $1.50 per share.

 

The Opportunity:

We have been keeping a watchful eye on opportunities in the community and regional banking sector.  After our successful investment in Broadway Financial, a small Los Angeles bank in January, we have been on the lookout for another bank where we could pick up shares of a well-run institution at a good price.

We like this sector because it remains undervalued.  It is still unfairly punished by the markets.  Many bank stock prices are locked in a holding pattern as investors await anticipated interest rate increases, and this has put a ceiling on stock price growth.

The big global banks like J.P. Morgan Chase, and, to a lesser extent, Wells Fargo, scare us.  There are too many uncertainties, both economic and political.

But a small bank that takes deposits and makes loans in the town it does business, and steers clear of trading derivatives and currency swaps, is easier to understand.

This is the thinking that drew us to Broadway Financial earlier this year, and it is what draws us to Central Federal today.

Central Federal has been around since 1892.  It is a holding company for CFBank, with four branches in Summit, Columbiana, and Franklin Counties in Ohio.

It’s a “meat and potatoes” bank.  Deposit products include savings accounts, retail and business checking accounts, CDs, and money market accounts.

The bank also makes personal loans, commercial loans, single family home mortgages, and commercial real estate and multi-family residential mortgage loans.

Central Federal also provides online banking, mobile banking, remote deposit, and corporate cash management services.

 

Financials:

Total revenue at Central Federal has been growing for the past three years.  It was $9.39 million in 2013, $12.10 million in 2014, and $13.75 million in 2015.

Net income has grown as well… $3.6 million in 2015 from a loss of $918 thousand in 2013.

On the balance sheet, asset growth has been consistent.  At the end of 2015, net tangible assets totaled $38.31 million, up 10% from 2014 and up more than 50% from 2013.

Margins are solid.  The profit margin is 40.9% and the operating margin is 18.51%.

 

Trade Rationale:

What we like about Central Federal is its momentum.  This is a turnaround in the making and the stock has not been recognized by the market.  Volume is low, typically less than 20,000 shares are traded a day.

Net income for Q1 2016 was $316,000, up $65,000, or 25.9%, compared to Q1 2015.

But the earnings growth does not come with the downsides of making risky loans.

Credit quality is solid.  Net recoveries for Q1 2016 were $46,000, or 0.06%, of average loans on an annualized basis.  The loan loss allowance was 2.19% at the end of the quarter.

Non-interest expenses of $2.5 million are holding steady.

Bank management is focused on loan growth, in both the personal and commercial segments.  The greatest upside in earnings growth will come from commercial loans, and the bank has added staff and strengthened its leadership to better address the opportunity.

 

Investment Risks:

The big risk is interest rates.  If they stay where they are, the bank will be hard pressed to make much money and deliver a healthy margin.  Even a modest rate increase will help.

Offsetting this is the possibility that the mortgage business will slow down as home buyers leave the market because of rising rates.

If the local economy sputters, and there’s a business slowdown, loan growth will be impacted.

We are also aware that while low volume signal can indicate a stock that is overlooked, it can also create a problem when the time comes to sell.  We typically like to see higher volume, but we are making an exception in this case because the community banking business is not prone to wild swings.

This isn’t a speculative biotech stock.  It’s a quiet bank in Ohio.

 

Potential Return: 

Central Federal stock took a hit in 2012 when it plunged from $5.00 to $1.50 in just two months.

The bank was bleeding money.  Net interest income was down, non-performing loans were up, and investors lost confidence.  Since the end of 2012, the stock has been trading below $2.00.

Twice this year, the stock has briefly fallen below $1.15.

We believe that Central Federal has put its house in order.  It has three years of growing revenues under its belt, and with continued improvement, the stock price can easily return to pre-2012 levels.

This doesn’t mean we expect this stock to immediately triple.  But we do expect consistent growth, and with consistent financial performance, a future where Central Federal again trades above $5.00 is in line with our expectations.

 

Key Facts:

Company:                                  Central Federal

Ticker:                                         $CFBK

Recent Price:                             $1.37

Buy up to Price:                         $1.50

Market Cap:                                $22.43 million

Avg. Daily Volume (3 month):        3,275

 

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Category: TPS Trade Alert