Cabot Micro-Cap Insider Issue: November 9, 2022

Financials Look Cheap

I’ve talked about it several times in passing, but I want to mention it again.

To me, financials look attractive.

Let’s start with the fundamentals.

The consumer is generally strong.

The latest example came from TransUnion’s Q3 earnings call.

“Thus far in 2022, consumer financial health has remained positive versus pre-pandemic conditions, supporting growth across TransUnion, especially in our emerging markets. Consumer employment, income, spending, balance sheets, and credit performance have been strong year-to-date.” – TransUnion ($TRU ) CEO Christopher Cartwright

And delinquencies are low (albeit starting to rise).

“…our consumer delinquencies remain well below pre-pandemic levels. And as Brian noted earlier, we’re watching closely the early-stage card delinquencies as they begin to increase modestly.” – Bank of America ($BAC ) CFO Alastair Borthwick

Rising rates should increase banks’ ability to earn higher net interest margins.

And valuations remain reasonable.

Two financials that I like a lot are Truxton Corporation (TRUX) and Esquire Financial (ESQ).

Truxton is trading at just 10x earnings yet growing EPS at 11%. Esquire is trading at 11x earnings and growing EPS 21%.

Today, I’m recommending another financial.

The stock is set to more than double earnings over the next three years yet trades at just 13x earnings.

With that, let’s dig into M&F Bancorp (MFBP) …

New Recommendation: M&F Bancorp: A Cheap Bank Taking Advantage of a Special Situation

Company: M&F Bancorp
NYSE: MFBP
Price: 18.01
Market Cap: $35 million
Price Target: 44.00
Total Return Potential: 145%
Recommendation: Buy under 21.00
Recommendation Type: Rocket
Executive Summary

M&F Bancorp (MFBP) is taking advantage of an interesting opportunity (Emergency Capital Investment Program) available to many small banks. As a result, I expect EPS to grow from $1.36 in 2021 to $4.74 in 2025. Assuming M&F continues to trade at its average P/E multiple of 9.3x, the stock should hit 44.00 by 2025, implying almost 150% upside.

Overview

Background
M&F Bancorp, Inc., headquartered in Durham, North Carolina, is a bank holding company whose subsidiary is Mechanics and Farmers Bank.

M&F Bank is a historic independent community bank committed to meeting the needs of a wide range of individuals and businesses

The company conducts its operations through branch offices of M&F Bank, which are located in five major cities in North Carolina: Durham, Charlotte, Raleigh, Greensboro and Winston-Salem. In addition to M&F Bank’s branch offices, the Bank owns six ATMs.

In total, the bank has eight locations in North Carolina.

The company was founded over 100 years ago.

At the turn of the 20th century, African Americans were navigating tremendous obstacles in the fight to participate in the economy.

For African Americans, there were few opportunities to obtain financing for their business ventures or homes. There were equally few options to safely place money on deposit and earn interest with established banking institutions, so, the black community created their own: M&F Bank.

The company has been public since the early 1990s and is trading close to an all-time high.

Insider Ownership
As Cabot Micro-Cap Insider subscribers know, insider ownership is high on my checklist and is critical when investing in micro-caps.

As detailed above, the trust of late billionaire Gene Phillips owns 86% of the company. The trust is controlled by his children.

They are highly incentivized to maximize value. The one caveat is we need to be careful that these majority shareholders don’t “squeeze” us out. In other words, buy the rest of the company for a minimal premium.

While this is a possibility, I think it’s unlikely as the company would likely be sued.

Valuation and Price Target
The VAA joint venture was held on TCI’s books at $50.6MM. Given that TCI will realized ~$300MM of proceeds from the transaction book value per share is going to increase materially.

Book value per share currently stands at $44 per share and over the past 5 years, TCI has traded on average at ~1.0x book value per share.

Total assets have grown nicely over time.

Outlook
M&F Bancorp’s outlook is extremely strong.

And it’s all due to a government program called the Emergency Capital Investment Program (ECIP). This Investopedia page does a nice job explaining the program.

It was established in 2021 so that low- and moderate-income community financial institutions could make more loans to small businesses and consumers.

Only community development financial institutions (CDFI) and minority depository institutions (MDI) are eligible to receive ECIP funds.

In total, $2BN was set aside for CDFIs and MDIs with less than $500MM in assets and $2BN was set aside for CDFIs and MDIs with less than $2BN in assets

Alluvial Capital, Cedar Creek Capital, and Dirt Cheap Stocks have all written about the ECIP program and the opportunity that it has created.

But to summarize, the Treasury is offering qualifying financial institutions the ability to sell to the Treasury preferred stock at extremely generous terms. The preferred stock is perpetual (meaning it never needs to be paid back) and has a maximum dividend of 2%.

CDFIs and MDIs can use this capital infusion to double or triple their earnings by increasing their loan portfolio and pocketing the difference between what their loan portfolio is yielding and their ECIP cost of capital (2% at max).

There are many banks that will benefit from the ECIP program, but my favorite is M&F Bancorp.

It received $80MM of capital from the ECIP program and by my math, the bank should be able to use this capital to grow earnings by ~250% over the next three years!

Insider Ownership
As Cabot Micro-Cap Insider subscribers know, insider ownership is high on my checklist and is critical when investing in micro-caps.

In total, M&F insiders and management own 5.1% of shares outstanding. I usually like to see higher insider ownership (at least 10% to 20%), but in this case, I’m fine with the insider ownership for two reasons.

• 1% ownership is still meaningful.
• The fundamental set-up for this stock is very attractive.

Valuation and Price Target
In 2021, M&F generated $2.7 MM of net income (EPS of $1.36).

Its average shareholders’ equity in 2021 was $33.2MM.

Thus, M&F generated a Return on Equity (ROE) of 8.1%.

Given, the injection of capital from the Emergency Capital Investment Program, M&F’s shareholder’s equity has increased to $115.7MM as of Q3 2022.

If we assume that M&F can put its excess capital to work over the next three years and earn the same ROE, it should be able to generate EPS of $4.74 by 2025.

Just to summarize, it’s likely that EPS is going to increase from $1.36 to $4.74 over the next three years.

What is the right valuation multiple to apply to those earnings?

Since 2019, M&F has traded at an average P/E ratio of 9.3x. Assuming that’s the right multiple, a fair valuation is 44.00 per share (9.3 x $4.74) by 2025.

As is always the case, micro-caps are illiquid. Be sure to use limits.

My official rating is Buy under 21.00

Risks

Current Loan Quality

• Loan quality currently looks good. As of Q3 2022, the company’s loan loss provision is just 1.2% of loans. Nonetheless, losses could increase over time given the macro environment.

Future Loan Quality

• M&F could rush to deploy the ECIP capital that it received. This could result in poor-quality loans and high future losses. I’m not overly concerned with this risk given the bank has been around for over 100 years and has survived many market cycles, but it’s something to keep an eye on.

Recommendation Updates

Changes This Week:
Sell Crossroads Impact Corp (CRSS) to make room for new recommendation.

Updates

Aptevo (APVO) had no news this week. On September 19, 2022, the company announced that the FDA has approved the company and its partner, Alligator Bioscience, to proceed with a new investigational drug ALG.APV-527 to treat multiple solid tumors. This isn’t major news but shows that the company has several promising shots on goal. Aptevo reported quarterly results on August 11. The company continues to report positive results from its key drug, APVO436. Further, it has additional drugs that are progressing well. Aptevo renegotiated its royalty agreement with Pfizer which allows Aptevo to recognize a gain and regain compliance with Nasdaq’s shareholder equity listing requirement. This is a positive. Currently, Aptevo has $25MM of net cash on its balance sheet and projects that it has enough liquidity to continue to operate for 12 more months without raising capital. This biotech bear market is no fun, but Aptevo continues to be an asymmetric bet. Original Write-up. Buy under 7.50

Atento S.A. (ATTO) had no news this week. It will report earnings on November 15. On September 7, Atento announced that it extended its lockup agreement with its largest shareholders (who represent 71% of shares outstanding) for 12 months. This is meaningful as it shows the largest shareholders of the company have conviction in the stock and believe it’s undervalued. On August 3, Atento reported another weak quarter. Management lowered revenue guidance to flat versus the consensus of +4% growth and previous guidance of “mid-single-digit” growth. EBITDA margin guidance has been reduced to 12% (at the midpoint) from 13.5%. While this quarter and guidance cut were disappointing, the stock is incredibly cheap and is not at risk of defaulting on its debt (no maturities until 2025). Thus, it makes sense to stick with the stock. Original Write-up. Buy under 10.00

Cipher Pharma (CPHRF) had no news this week. On September 22, the company announced that it has approved a share repurchase authorization to buy back 1.4MM shares (10% of float, 6% of shares outstanding). This is a positive. The company reported strong results on August 11. Revenue declined 8% driven primarily by lower Absorica sales (as expected); however, adjusted EBITDA grew sequentially to $3.6MM. The company’s cash balance stands at $24.2MM, ~50% of its market cap. This limits downside risk. Further, the company continues to generate significant free cash flow and buy back shares. Finally, the company had positive pipeline developments with two compounds (MOB-015 for nail fungus and Piclidenoson for psoriasis). Both drugs are progressing in phase III trials. Original Write-up. Buy under 2.50

Cogstate Ltd (COGZF) had no news this week. However, the company got a boost when Esai and Biogen announced positive results for its Phase 3 Alzheimer’s Trial on September 27. This is massively positive news as it will drive more Alzheimer’s trials (and revenue for Cogstate). Ultimately, Cogstate’s revenue potential this year and beyond will be determined by key Alzheimer’s drug read-outs which are expected this year and next year: 1) Lecanemab from Eisai (Phase 3 data: already announced and positive), 2) Gantenerumab from Roche (Phase 3 data expected in Q4 2022), and 3) Donanemab from Eli Lilly (Phase 3 data in mid-2023). The Cogstate thesis remains on track. Original Write-up. Buy under 1.80

Copper Property Trust (CPPTL) announced that it will pay out $0.39 per certificate on November 10. On September 12, the trust announced that it sold seven of its properties for $65MM. The blended cap rate of the transactions was 7.3%. The trust on an aggregate basis is trading at a ~10% cap rate (the higher the cheaper). Copper Property Trust continues to look attractive. Original Write-up. Buy under 14.00

Crossroads Impact Corp. (CRSS) had no news this week, but I’m changing my rating to Sell for the stock. I still like the stock and believe it has positive fundamentals, but I’m capping my open recommendation list to 20 stocks. Thus, I’m selling Crossroads to make room for my new recommendation this month. Original Write-up. Sell

Currency Exchange International (CURN) had no news this week. It reported earnings on September 13th. They looked great! Revenue increased 139% to $21MM, beating consensus expectations by $5MM. This was truly a massive beat. Revenue in the fiscal third quarter was 67% higher than 2019 FQ3 (pre-pandemic). The company’s Payments business grew revenue 65% to $3.6MM. Year to date, Currency Exchange has generated EPS of $1.15 or $1.53 on an annualized basis. As such, the stock is trading at just 9x earnings. The investment case remains on track. Original Write-up. Buy under 16.00

Epsilon Energy (EPSN) had no news this week. It will report earnings on November 10. The company announced strong Q2 results on August 11. Epsilon continues to benefit from high natural gas prices. Revenue increased 46% sequentially, driven by 68% higher natural gas prices. Revenue should continue to soar as long as natural gas prices remain elevated and Epsilon is mostly unhedged. During the quarter, the company generated $5.9MM of free cash flow, or $23.4MM on an annualized basis. The stock looks attractive given its $31MM of net cash and strong earnings power. Original Write-up. Buy under 8.00

Esquire Financial Holdings (ESQ) had no news this week. It reported earnings on October 25. EPS increased 21% to $0.94. Return on assets and equity were 2.48% and 20.60%, respectively. Credit metrics remain strong with nonperforming loans of 0.67% and a reserve for loan losses of 1.24%. I continue to believe Esquire dominates an attractive niche and is set to grow nicely for the foreseeable future. Despite 21% EPS growth and strong credit metrics, Esquire trades at just 11x forward earnings. Original Write-up. Buy under 42.00

IDT Corporation (IDT) had no news this week. It reported fiscal Q4 earnings on October 6. Similar to last quarter, revenue declined y/y (down 16%), mainly due to tough comps from last year. However, the two most important segments, NRS and net2phone, continued to generate excellent results. NRS revenue grew 157% to $17.7MM, with full-year 2022 recurring revenue increasing 129% to $45.3 million. net2phone subscription revenue increased 37% to $15.1MM. Overall, it was a solid quarter. The investment case remains on track and my price target is 55 based on an updated sum-of-the-parts analysis. Original Write-up. Buy under 45.00

Kistos PLC (KIST: GB) had no news this week. The company reported first-half 2022 results on September 7. They looked great. The company reported revenue growth of 745% and EBITDA growth of 768%. It generated free cash flow of £93MM or $186MM annualized. Kistos has pulled back due to falling natural gas prices in Europe. As such, Kistos is currently trading at 0.7x annualized EBITDA and 1.8x annualized free cash flow. This is too cheap. Another risk is that the EU is considering instituting a windfall profit tax on energy companies. While this would be a negative, I think it’s reflected in Kistos’ valuation. Further, Kistos generated $89MM of EBITDA in 2021. Thus, it’s trading at just 3.5x “normalized” EBITDA, not a demanding valuation. I continue to see at least 100% upside ahead. Original Write-up. Buy under 7.50

Liberated Syndication (LSYN) has had no news recently. Libsyn’s plan was to “go public” again in September. Obviously, that didn’t happen. It isn’t too surprising given the market volatility. I’ve reached out to Libsyn’s CEO and hope to catch up with him soon. Libsyn has posted several press releases in the past couple of months. I remain optimistic about Libsyn’s prospects. Once financials are re-filed, I’m looking forward to seeing: 1) How Libsyn’s core hosting business is doing. Podcasting conferences were a key way that Libsyn marketed. When COVID shut down in-person events, it negatively impacted Libsyn’s new customer acquisition. Now that COVID is behind us, I expect the core business to accelerate. 2) Revenue growth for AdvertiseCast. This is an exciting business opportunity Revenue grew 50% in 2021 for AdvertiseCast, and I expect continued strong growth going forward 3) The growth of Glow. Libsyn acquired Glow in 2021. Glow enables podcast creators to offer premium shows (think substack but for podcasts). I think this is a big market opportunity. While Libsyn has been a frustrating stock, I think (and hope!) our patience will be rewarded. Original Write-up. Hold

Medexus Pharma (MEDXF) reported fiscal Q2 results last night. The report was excellent! Revenue grew 55% y/y and EBITDA was $4.2MM, a y/y improvement of $6.3MM. The company generated positive free cash flow and is actively exploring options to refinance its convertible debentures which come due next fall. The stock’s valuation looks cheap at 1.1x revenue and 7.6x adjusted EBITDA. The investment case remains on track! Original Write-up. Buy under 3.50

NexPoint (NXDT) had no news this week. It recently declared its quarterly dividend of $0.15. Unfortunately, this isn’t an increase from its previous $0.05 monthly dividend. Nonetheless, the company has many important upcoming potential catalysts: 1) Q3 results 2) potential share buyback 3) potential spin-offs. The thesis remains on track, and I see ~50% upside in the next 12 months. Original Write-Up. Buy under 17.00

P10 Holdings (PX) announced on October 13 that it closed its acquisition of Western Technology Investment, a market leader in venture debt. The acquisition will add $12.5MM of additional EBITDA to P10. It appears that P10 is paying ~12x EBITDA for the acquisition, a cheap but not dirt-cheap price. This acquisition will add to P10’s growth potential. P10 is currently trading at 15x 2022 adjusted EBITDA which is a very reasonable valuation for such a stable business with strong organic growth potential. The investment case remains on track. Original Write-up. Buy under 15.00

RediShred (RDCPF) had no news this week. It last reported earnings on August 26. Results were excellent! Revenue grew 68% to $14.6MM CAD while EBITDA grew 73% to $4.5MM CAD. While acquisitions are helping, organic growth is very strong (+40% y/y). The stock continues to look incredibly cheap at a 5.1x EV/EBITDA multiple and a 7.4x price to free cash flow multiple. I continue to see 100% upside over the next 12 months and significantly more upside looking out a few years. Original Write-up. Buy under 3.50

Richardson Electronics (RELL) had no news this week. It reported earnings on October 6. Revenue grew 26% to $68MM, beating consensus expectations by $5MM. EPS of $0.45 beat consensus expectations by $0.21. The stock reacted well. The company is a rapidly growing micro-cap that is benefiting from many “green” initiatives (electric trains, wind turbines, etc.). Despite strong growth expectations and a pristine balance sheet ($40MM of net cash), the stock trades at just 12x next year’s earnings. Insider ownership is high, and I see ~50% upside over the next couple of years. Original Write-up. Buy under 17.00

Transcontinental Realty Investors (TCI) filed an 8-K that disclosed it received $203.9MM in proceeds from the sale of its JV. Adding this to the $100MM that the company already has received, and Transcontinental has 96% of its market cap in cash. Once the transaction is reflected in Q3 2022 financials, Transcontinental should see a big boost as investors recognize value that has been crystalized. Finally, insiders own 86% of the company and could make an imminent move to buy out remaining shareholders at a large premium to the current stock price. Original Write-up. Buy under 45.00

Truxton (TRUX) reported Q3 earnings on October 20^th. They were very good. Net income in the quarter of $1.49 grew 11% y/y. Net revenue also grew ~11%. Credit metrics remain excellent with $0 in non-performing loans. On an annualized basis, Truxton is generating $5.96 in EPS. It is trading at 10.4x annualized earnings. Historically it has traded at 13.5x. This isn’t the most exciting stock, but it’s a slow and steady winner. Original Write-up. Buy under 75.00

Zedge, Inc. (ZDGE) pre-announced results on November 1. Fiscal fourth-quarter revenue came in at $7.4MM, growing 37% y/y. The growth was primarily driven by the acquisition of GuruShots which contributed $1.7MM of revenue in the quarter. Zedge didn’t share full results as its 10-K is not ready yet. The reason? Its accounting firm was acquired by another firm and that has resulted in delays in the finalization of the 10-K. Total users of Zedge’s flagship app declined 7% y/y. While this is a concerning trend, the company is still profitable and has ample opportunity to drive revenue synergies with its GuruShots acquisition. Further, the Zedge has $12MM of cash on its balance sheet (my estimate, 1/3 of market cap) and trades at 2.0x EBITDA. Further, the company is buying back stock. Original Write-up. Buy under 6.00

Watch List

Enhabit (EHAB) is a new name on my watch list. It is a 2021 spin-off that has performed poorly. It is focused on the home health and hospice space. Revenue is currently declining slightly due to health care worker shortages, but eventually, I expect revenue to reaccelerate. The stock looks very cheap, trading at 6.0x free cash flow. Meanwhile, insiders have been aggressively buying shares. The stock chart looks horrible, but this stock probably has significant upside looking out 2-3 years.

Harbor Diversified (HRBR) remains on my watch list. It is the holding company for Wisconsin Airlines, which has a capacity agreement with United. HRBR trades at a cheap valuation because there was uncertainty regarding whether United would extend its contract with Harbor. However, the company recently disclosed that the contract has been extended for five years. No terms have been released yet, but the stock should re-rate higher over time.

Inventronics Limited (IVX.V) remains on my watch list. It’s a Canadian micro-cap that designs, manufactures, and sells protective enclosures for the telecommunications, electric transmission, cable and energy industries. It’s growing revenue nicely yet only trades at an EV/EBITDA multiple of 5.2x. It even just paid a nice dividend (10% yield). I will continue to watch this name. It has started to consolidate a bit. If I’m able to get comfortable with the sustainability of the growth outlook, I will likely recommend it.

**Original Price Bought adjusted for reverse split.
* Return calculation includes dividends

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Rich Howe owns shares in PX, MEDXF, LSYN, IDT, DMLP, NXDT, KIST, and RDCPF. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.

The next Cabot Micro-Cap Insider issue will be published on December 14, 2022.