Renewable Energy And Farm Loans Propel Robust Revenue And Margin Growth

Key Takeaways

• Growing focus on renewable energy loans is expected to drive higher revenues, aligning with their mission and enhancing net effective spreads.
  
• Proactive capital management and disciplined asset liability strategy position Farmer Mac for margin improvements and long-term profitability.
  
• Strategic management of credit risk, volatility in AgVantage securities, projected decrease in farm income, and increased funding costs pose challenges to net earnings and revenue growth.

Catalysts

Provides a secondary market for various loans made to borrowers in the United States.

• The growing focus on renewable energy loans, where loan purchase volume in this segment has more than doubled since last year, is expected to continue driving higher revenues and net effective spreads due to strong demand for renewable power generation and storage. This aligns with their mission while being accretive to revenues.
  
• The high volume of new business, particularly in the Farm & Ranch segment where $700 million of new farm and ranch loan purchase volume was closed in the first half of the year, indicates strong momentum and potential for increased revenue through loan securitization, spurred by tight bank liquidity and adjustments to higher interest rate environments.
  
• Agricultural loan volume is anticipated to rise due to forecasted declines in farm income and a potential easing of Federal Reserve policies, which could lead to more loan purchase opportunities, thereby increasing business volume and impacting revenue positively.
  
• The practice of proactive capital management, such as opportunistically lengthening the tenor of their liquidity investment portfolio, positions Farmer Mac to potentially benefit from a Fed easing cycle, mitigating volatility from rate decreases, and could lead to margin improvements and higher net interest income.
  
• The execution of a disciplined asset liability management strategy, maintaining strong capital levels, and a robust securitization program enables Farmer Mac to issue long-dated fixed-rate debt, which could result in consistent spreads across business cycles and bolster long-term profitability through enhanced net effective spreads.

Assumptions

• Analysts are assuming Federal Agricultural Mortgage's revenue will grow by 6.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 50.1% today to 51.3% in 3 years time.
• Analysts expect earnings to reach $220.6 million (and earnings per share of $19.5) by about September 2027, up from $179.4 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.8x on those 2027 earnings, up from 11.1x today. This future PE is lower than the current PE for the US Diversified Financial industry at 15.2x.
• Analysts expect the number of shares outstanding to grow by 0.41% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 10.74%, as per the Simply Wall St company report.

Risks

• The partial charge-off of a single permanent planting loan indicates credit risk, specifically in the agricultural sector, which could affect loan performance and increase credit expenses, impacting net earnings.
  
• Volatility in the AgVantage securities business due to slower market loan growth and tightening of credit spreads, suggesting potential fluctuation in business volume that could impact liquidity needs and revenue from this segment.
  
• A decrease in farm income is projected, which may affect the demand for loans and subsequently impact new business volume and revenue growth in the Farm & Ranch segment.
  
• The increase in funding costs from the opportunistic issuance of debt at advantageous rates indicates higher expenses, which could reduce net margins and earnings if not offset by proportionate increases in revenue.
  
• The strategic sale of investment securities and certain loans for rebalancing the liquidity investment portfolio and reducing credit exposure suggests potential losses from sales or revaluation of assets, affecting net earnings and capital ratios.

Valuation

• The analysts have a consensus price target of $218.0 for Federal Agricultural Mortgage based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $429.8 million, earnings will come to $220.6 million, and it would be trading on a PE ratio of 14.8x, assuming you use a discount rate of 10.7%.
  
• Given the current share price of $182.76, the analyst's price target of $218.0 is 16.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.