Description

*PA stock alert* 

Do you like short write-ups?  Have you been struggling to find the next asset play trading at a massive discount?   Do names such as Ash Grove Cement or Los Angeles Athletic Club (thanks zbeex) give you warm fuzzy feelings?  If so, get ready for a name that you’ve probably never heard of, generating a HSD FCF yield (on a zero debt, cash heavy balance sheet) and which will one day (hopefully) give you a nice surprise.   Don’t be discouraged by the trading liquidity, zero investor outreach and once a year financial updates… you’re a long term investor, right?

Key background

• Queen City Investments (ticker: QUCT) is a very illiquid OTC-traded publicly traded affiliate of a less illiquid OTC-traded regional bank called Farmers & Merchants of Long Beach (ticker: FMBL) which itself was recently written up on VIC

• QUCT is controlled by the Walker family (who also control FMBL) and was spun out of FMBL in the 1970s.  Please read the FMBL write-up on VIC and notice the conservative nature of the Walker family.

•  QUCT trades at a $58mm market value with a truly pristine balance sheet consisting of $30mm of cash/treasuries and zero debt.  QUCT generated about $4.4mm of FCF in 2022. 

• We estimate the SOTP is worth $118-$247mm ($2,450-$5,200/share) vs. stock price of $1,225/share and consists of:

o   1) a trust management business affiliated with Farmers & Merchants of Long Beach called Farmers & Merchants Trust Company (estimated $4-5mm of EBITDA)

o   2) a property portfolio ($1mm/yr NOI)

o   3) a cattle ranch of 27k acres (or more) in Central California generating virtually zero EBITDA

o   4) $25mm of short duration treasuries

o   5) private investments of $2mm.

• Discount to NAV may never close, or it may close tomorrow.  In the meantime, the company should generate $4.5mm+/year of FCF.  Company also bought back stock in 2021/2022 (small though) for the first time in years.

How to value the core assets?

• Trust business.  QUCT’s trust business, which manages $6bn of AUM, is its core cash flow generator.  QUCT does not break out cash flow by business line, but you can back into through the P&L, as the treasuries, property portfolio and cattle are distinct line items (so I use the residual as an estimate for the core trust business).   Over the last four years, trust fees have increased every year – from $11.6mm in 2019 to $14.3mm in 2022, with EBITDA peaking at $5.4mm in 2021 and down to $4.3mm in 2022 due to a $1mm increase in personnel costs.  It’s really hard to know exactly what the true run-rate earnings of this business is.  Given that it’s minimal capital and growing (for the most part), I assume a valuation of 10-15x EBITDA or $43-64mm.

• Property business.   QUCT has been reinvesting the profits of the business in real estate over the years, with 2022 EBITDA of $1.5mm, which I estimate translates into $1.1mm of NOI.  Based on 5-6% cap rates (given likely Southern California exposure), I arrive at a valuation of $18-21mm which compares to the book value at 12/31/22 of $20mm ($26mm at cost) for rent producing properties (as shown in footnote 5 of the Annual Report).

• Treasuries and privates.   For treasuries and privates I just use the fair value disclosures in the annual report.

• Cattle business.   QUCT’s cattle business generates no EBITDA but that is not the value here.  QUCT owns Messer Land & Development, which owns a 27,000 acre ranch near Huasna, CA.   Based on my due diligence (including speaking with real estate folks in Central CA), I think that the actual landholdings could be more, but 27,000 acres seems to be a number referenced in multiple places so I will use that.  The acreage is so extensive that it’s virtually impossible to come up with a good number.  There is a somewhat similar ranch closer to the coast that is offered for sale at $7,500 per acre (https://www.landandfarm.com/property/indian-knob-ranch-secluded-property-ocean-views-10912096/).   My checks indicate that the land is worth more than $1,000 per acre and could be worth a lot more, depending on the assumptions.  It's possible that some of it can be rezoned for a residential/commercial development but that would require seeking the entitlements in California.  To put it in context, one acre of mediocre land near LA could be worth $1mm, so even if a small % of the 27k+ acres could eventually be used for something, there could be a lot of value here. I use a valuation range of $1,000 to $5,000 per acre which comes out to $569-2,845 per share (vs. stock price of $1,225 today).

Operating Valuation

You can come at this a few ways. Last year net income was $3mm, thanks to some increased costs and an unusually high tax rate. FCF is higher, thanks to excess D&A. In addition, the treasuries, though short dated (1-5 years) were yielding only about 1.5%. Keeping the high tax rate, estimating maintenance capex at about $550k, bumping treasury yields to market, I get a “normalized” cash earnings of maybe $4.5 million, or about a 7.5% yield on market cap. Don’t worry though, you’re getting paid the princely sum of (squints) $10/share/year in dividends

Will the Walkers Ever Sell the Cattle Ranch?

The $64k question. I think they will absolutely sell the ranch in the next 5-10 years.  Why do I think that?  When I spoke to management (which was not easy to do), they described the asset as non-core.  Daniel Walker, who owns about half of QUCT’s stock, is 67 years old and besides playing polo from time to time in Santa Barbara I can’t find evidence that he actually goes to the ranch with any regularity.  In the meantime, the land value will continue to grow with inflation and one day shareholders should wake up with a nice surprise.

Risks:

• Dead Money / Value Trap

• Poor Real Estate Investments / Capital Allocation

• Related Party Transactions

Catalyst

Sale of cattle ranch

Dividend bump