Investing in Undervalued Banks: BNCCorp and Bank of Birmingham

I have spent so much time speculating that I have been neglecting the more long-term investment side of my portfolio. Here are two purchases that I made today to rectify that situation.

BNCCorp (BNCC.pk)

Since I wrote about BNCC.pk, a lot has changed with the company: the stock price has nearly quintupled, the assets and equity have both skyrocketed, and the company has been increasing earnings at unfathomable rates (year-over-year earnings growth was 505%). (Read the article for the whole story on this investment idea.)

BNCCorp still remains undervalued. The Price/Book ratio sits at just under .58. For such a fast growing area as North Dakota, I would expect most banks to be trading above their book values, not significantly below it. Therefore, it is probably a safe investment until it reaches .80 or so. At that point, it will begin to look significantly less attractive.

I am regretting selling out 80% of my position when the stock went up by 150%. I thought the move was largely over, and was eager to invest in other areas, but I neglected to check the real value of the company’s earnings potential and equity in relation to the market capitalization.

I am glad however, that I decided to let 20% of the position run. I have since purchased more shares, though it is always painful to buy back a stock you sold at a lower value.

The bank has increased its equity-to-assets ratio to 8.9%. Thus it is no longer a “cigar butt”, but instead is a well-capitalized bank in the fastest growing area of the nation. (For reference, Peter Lynch recommends an Equity-to-Assets ratio of more than 7.5% to qualify as a well-capitalized bank.)

North Dakota has exploded in population, and as these people settle into more permanent arrangements, the need for home loans and commercial loans will continue to be enormous. The Bakken Shale will remain attractive as an oil play at WTI prices above $80, and now that the European crisis fears are on the decline, oil prices have stabilized in the $90 range. They will likely remain high until the next financial crisis threatens global demand.

Though most of the explosion in the Bakken region is already played out, and though a large portion of the oil workers in the region have already found permanent housing situations, I expect the growth in the Price/Book multiple coupled with steady earnings (if not growing earnings) to secure the safety of this investment for the near future.

Bank of Birmingham (BBBI)

In addition, I have begun a new investment in the Bank of Birmingham (BBBI). The company has been sitting at a price/book ratio just under 1 for a few weeks, but a recent pre-announcement by the company suggests that the current Price/Book is closer to .58, suggesting the company is undervalued.

The Equity/Assets ratio is 11.1%, indicating that the bank is significantly under-leveraged.  This is a good thing: a less leveraged balance sheet makes a less risky investment. In addition, the extra equity means that the bank has significant room to expand its loan portfolio and increase earnings in the future.

With these low amounts of leverage, the bank was able to increase earnings 54% over the course of 2012 (excluding a deferred-tax asset recognition in 2011). This rapid earnings growth rate is a testament to the earnings power of this bank.

So why has this bank been growing so quickly? The answer is simple: the rebound of the car industry.

The Bank of Birmingham is located in Birmingham, Michigan, on the outskirts of Detroit, so it is dependent upon the comeback of the auto industry. As Birmingham is a wealthy suburb, it is less-exposed to pullbacks in the U.S. automotive market than urban Detroit. As long as the auto industry comeback is not derailed by a significant U.S. recession, we should expect more suburban migration and an expanding population in Birmingham, leading to more deposits, loans, and mortgages issued.

Disclosure: I am long BNCC.pk and BBBI.

The Short on 3D Systems Corporation (DDD) is Finally Paying Out

I was a little too eager to call an end to the twilight phase in my Seeking Alpha post two weeks ago. I did not anticipate the large run up in the stock, but probably should have. At the peak of a bubble, it is normal to see a test of the highs.

As the stock rose last week, I shorted shares, but did not add to the options positions. Risk control is easier when shorting a stock outright than in buying put options, because I can set a stop limit that is logically derived. For 3D Systems Corporation (DDD), the natural stop limit would be in the $72-73 range, because this is the all-time high for the stock. If it were to blow through this point, it will have passed a test, and the reflexive boom phase could continue for the foreseeable future.

However, it seems that this week has shifted the momentum back to the negative. I feel more secure in the short position now. In a reflexive bust, the further the stock declines from the high, the more likely it is to continue declining, until the stock reaches undervaluation territory. For DDD, I would not be interested in investing on the long side until the stock nears $30/share.

The only risk to the bust process at this phase is the upcoming earnings announcement on February 25. I suspect these earnings will show high growth rates, because the stock was so highly priced during the fourth quarter that 3D Systems Corporation could spend freely on capital expenditures and acquisitions for growth.

This alone would be a positive event for the stock price. However, the perception on the stock has already shifted. According to George Soros’s model of reflexive boom-bust processes (see model in my DDD article here), it is typical for the stock to continue declining for a significant period after the peak, even as earnings increase. That is, the peak in earnings typically follows the peak in stock price (this is due to the delay of acquisitions’ effects on earnings, coupled with the 1-2 month delay in reporting earnings). So good earnings will not necessarily de-rail the bust process.

But it pays, in the long run, to be cautious. Therefore I will likely reduce my short position before the end of next week to lower my exposure to an earnings-related upward move. But, in the mean time, I am letting my profits on the short position run, and am considering adding to it to cash in on a likely move downwards during the beginning of next week.

Disclosure: I am short DDD via stock sales and the purchase of March and May $45 put options. I am considering shorting additional shares of DDD in the next 72 (business) hours.