SACH - Sachem Capital: Deteriorating Investor Sentiment Overshadows The Growth Potential

2023-03-22 08:38:44 ET

Summary

• Given SACH's competitive advantage and the potential in its market, the company's new credit facility has been met with a great deal of optimism.
• The recent drop in the company's share price has contributed to poor investor sentiment, which I believe will lead to a further decline in share price.
• The company's declining return on invested capital also causes some skepticism about the potential benefits of the new credit line.

Investment Thesis

Sachem Capital Corp. (SACH) is a company that finances real estate. The company manages a portfolio of short-term loans that are originated, underwritten, funded, serviced, and secured by first mortgage liens on real estate, predominantly in Florida and the Northeastern United States.

SACH has excellent earnings. Over the last five years, SACH's earnings have increased by 20.2% annually. SACH's earnings growth over the previous year (45.7%) was higher than the sector of Mortgage REITs (20.4%). This, in my opinion, was brought about by rising sales. Compared to the three months ending June 30, 2021, the total revenue for the three months ending June 30, 2022, was about $12.5 million, an increase of approximately $5.8 million, or 86.9%. This strong revenue growth was primarily due to an increase in their lending operations.

The interest income for the 2022 period was about $10.4 million, up from about $4.7 million for the 2021 period, an increase of approximately $5.8 million, or 122.8%. This strong growth is primarily because of the increased lending operations, which I believe are a result of the opportunities in the company's business environment.

The company has established a $45 million revolving line of credit with Needham Bank in light of this significant development and what I anticipate to be a significant demand for its products. In my opinion, this credit facility is appropriate in light of the company's opportunities and low liquidity. I am confident that the organization will see positive returns and satisfying future outcomes if it properly uses this facility. Unfortunately, the market appears to overlook this growth potential, which could lead to a decline in the stock price given the company's lower FWD PE ratio. This leads me to give the stock a "hold" rating.

New Credit Facility: Enhancing Capital and Liquidity to Support Growth

SACH and Needham Bank agreed to a revolving line of credit in the amount of $45 million . According to Mr. John, the CFO, the credit facility will increase the company's liquidity and provide more financial flexibility, which will be critical for its growth.

Mr. John Warch , "Given our growing pipeline of opportunities, we are pleased to close on this attractive financing as it significantly enhances Sachem's financial flexibility and liquidity. This additional line of credit provides the financial capacity to scale our business further and execute our growth strategy. We appreciate the confidence and strong support of Needham Bank as we look to continue to grow into the future."

The Corporation intends to use the proceeds from this credit line to meet its working capital requirements, for general company purposes, and to finance the origination of new mortgage loans. With the help of an accordion expansion provision, the limit of the revolving credit facility can be raised to $75 million, but only if enough participating lender pledges are obtained.

Why This Credit Matters

There are two main reasons why I think this credit facility is necessary and warranted:

• Low liquidity
• Opportunities in the market

Liquidity Factor

When it comes to liquidity, SACH has very little. The company has cash and other assets worth $35.46M, much less than its debt level of $326.96M. This means the company has negative net cash, which puts it in a precarious situation. I think this credit facility will help the company's short-term liquidity, and the cash flows from the capital invested will help the company's long-term liquidity.

Opportunities

The market in which SACH works has a promising prospect, and as a result, I think this credit facility is good and will pay off for the company. Refinancing operating capital and funding the creation of new mortgage loans were two of the main reasons for tapping into the facility. Given the foregoing information, the following is my assessment of the company and its potential in the market.

• Growing demand for home mortgages

Despite recent volatility in mortgage rates, mortgage borrowing has increased . The seasonally adjusted index maintained by the Mortgage Bankers Association showed a 6.5% increase in total application volume some weeks ago. The number of people applying for mortgages to finance a house purchase increased by 7% despite higher rates. A total percentage point increase in mortgage rates in early February effectively halted the housing market, but there is some evidence that buyers are beginning to return.

• Providing low-cost loans with good credit

Well-capitalized "hard money" real estate finance companies can originate affordably priced loans with asset-based solid fundamentals. SACH operates in the Northeast but has expanded nationwide. Real estate values in many communities are stable or rising. Substandard properties are being restored, rehabilitated, and refurbished, creating many opportunities for "hard money" lenders to provide funding to small developers. Small real estate developers and investors prefer them to banks and other major institutional lenders because they can tailor loans to meet their borrowers' needs and close swiftly.

• Gaining an Edge in the Market

With a significant competitive edge in the market, SACH can better use the loan facility available to them. A few of the firm's key competitive advantages that I see as essential to its long-term success are described below.

Prudent lending practices : To assess each transaction's possible risks and benefits, SACH employs stringent underwriting and loan closing procedures with many checks and balances.

Vertically-integrated loan origination platform: They oversee the loan process from origination to closing with their staff or trusted third parties like legal counsel and appraisers.

Adaptability in design: Since they are a small, non-bank, locally-focused real estate lender, they can act swiftly and have considerably more flexibility than big banks when it comes to structuring loans to meet the needs of their clients.

Free from legacy issues: Unlike many of their competitors, they don't have to deal with legacy real estate assets that are in trouble.

With these attributes, I think SACH is in an excellent position to capitalize on the market and use the credit facility it received, especially now that demand appears to be on the rise.

Valuation

For investors to make informed decisions on Sachem Capital, they must know the company's worth. Knowing Sachem Capital's true worth is crucial so that the investor can make more informed decisions and that investors and analysts can more accurately predict the company's future financial health. Investors may get a good sense of Sachem Capital's worth by looking at its enterprise value and market capitalization.

Compared to other companies in the same industry, the market capitalization of Sachem Capital Corp ranks below average. The Financials sector is valued at around $16.45B at present. With a current market worth of $140.34M, Sachem Capital accounts for less than 1% of Financials sector equities.

Compared to similar firms, the price-to-earnings ratio of Sachem Capital Corp is below average. Compared to similar companies, which typically report a P/E ratio of 1.22 after five years, it has a below-average return on investment.

The Price-to-Earnings Ratio of 9.1 for SACH is lower than its peer group's average (15.2x), meaning the company is undervalued.

Even though the company is undervalued right now, it has an A FWD PE of 7.53X, which means the market is not optimistic about this stock's future. I think the market is ignoring this company's strong potential to a large extent, especially after its shares dropped 15% last week and investor sentiment got worse.

Risks

Although I am very optimistic about the company's prospects following its competitive advantages and the opportunities in the market, I am concerned about the company's invested capital against the return on invested capital.

The firm's invested capital has grown substantially during the past five years, but the returns on those investments have plummeted. Given these interrelationships, I am somewhat pessimistic about the new loan facility's impact on capital investment and, by extension, returns.

Conclusion

The recent drop in the company's share price has contributed to poor investor sentiment, which I believe will lead to a further decline in share price. The company's declining return on invested capital also causes some skepticism about the potential benefits of the new credit line. Taking this into consideration, I have a hold rating for the company.

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