-Bank stocks down 40% on COVID-19 pandemic and economic shutdown fears

-Bank OZK among best run, mid-sized US banks; sports league leading industry metrics

-Strong culture, business and track record, I see up-to-50% rise possible post-COVID-19

Financial stocks remain the bleeding edge of the bear market, even as some areas of the market, notably technology and growth stocks, have recovered nicely. Bank stocks have been a whipping boy and their shares have recovered a bit but are still struggling.

Nevertheless, if you are an investor who values and wants a diversified portfolio, there is an opportunity possible in quality regional banks that should come out of this crisis with their profitability and business outlook intact for the long term. The banking industry has taken a hit from the coronavirus (COVID-19), but I believe it will recover. That’s the first tenet in this thesis.

Regional banks in particular were down fell over 50% at March 23, the market low point and they remain down about 40%, so there has been no “V” shaped recovery for them. But, as I have noted in previous reports, the industry has a preeminent position in the American industrial eco-structure. 

The group isn’t much liked, and that’s a contrarian attraction for me.  Also, according to Bespoke Investment Group, this 40% drop is only the fifth such drawdown for the sector since 1940.  Following prior periods of similar 40% declines from a 52-week high, once the group moved out of the 40% drawdown range, short-term returns were mixed. However, one year later the sector was higher all four times. That gives me, at least, some solace that there is a light at the end of the tunnel for the group.

If there is an economic recovery, and I think there will be, then banks will eventually recuperate, too. I don’t exactly know when, but if you can find a well-run bank with a profitable and well-positioned geographic footprint and whose shares are cheaper than they’ve been in a long while, it would be worth a look. I think  one such bank is Bank OZK (OZK), previously known as Bank of the Ozarks, about a $2.7 billion market cap regional bank with about 250 or so branches in ten mostly southeast and south central states, some of the fastest growing states in the union.

OZK has a lot to offer. First and foremost, it has a strong culture, established at the top by George Gleason, the chairman and CEO at the Arkansas-based bank. He’s generally credited with being the driving force there for much of his 41 years at the bank, setting the culture for lending and capital allocation, and shareholder stewardship.

He’s imbued upper management—which has an average tenure of 14 years—with a strongly pragmatic, results-oriented and no-nonsense way of doing business, avers Rob Lutts, president and chief investment officer at Cabot Money Management in Boston. Lutts is a fan of the bank and Cabot has purchased shares for its clients in the recent downdraft at prices close to the current level.

OZK shares trade around $19, down from the all-time high of nearly $33 before the COVID-19 pandemic hit the stock market, and up from a low of about $14 in March. The last time the stock was this low was seven years ago, when profits were far smaller at $88 million, or $1.21 per share. In 2019, they were $426 million or $3.30. More on this below. Lutts’ calls the stock a bargain at this price, and I have to agree.

OZK is plain vanilla banking—commercial and consumer loans, deposits and real estate—at its best. The proof of its prowess is that OZK consistently leads its peers in nearly all the important banking metrics, from net interest margins (chart below) to return on average assets to efficiency ratios to net charge offs. (See chart at left.)

Like all banks, OZK is battling ever lower interest rates and margins are squeezed, but it continues to perform better than peers. Long term compounded annual profit growth (CAGR) has been 28%. Even as interest rates have generally fallen for a decade, OZK’s net interest income as grown at a CAGR of over 22%.

It’s a bank where management has been able to use all the tools at its disposal to do well in a challenging environment, Lutts notes. Whenever the industry takes a hit OZK isn’t immune, but its problems tend to be less than others. In the third quarter, for example, its net interest margin was 4.26 vs. 3.35% for the industry (latest data available). And OZK didn’t lose money in the Great Financial Crisis of 2008-2009, Lutts points out.

OZK is an opportunistic bank and it will be interesting to see what the bank does now.  For example, OZK doesn’t buy back much stock, but perhaps during this period it will, Lutt’s opines.  Management is a good steward of capital, he says.

Indeed, the shares trade at a price-to-book value of about 0.7 times, below its recent history of 1.1 to 1.3 times. And while earnings per share estimates for 2020 might be a crap shoot, its 2021 P/E of 9 times is below a historical average of 12 times and peer average of 11 times. OZK also has a dividend yield of almost 5%, so you get paid to wait for the stock to recover.

To some extent, OZK’s size and business area means it tends to fly under the Wall Street radar. Only ten analysts follow it and just 3 have a Buy rating. I think in a full recovery scenario, OZK stock could begin to approach its old highs, or an up to 50% rise. When that is I can’t say. “That’s reasonable value on what we know now,” adds Lutts.

The weak spots in OZK’s business currently are two.  It’s growth has slowed a bit lately, but most of that is due to higher infrastructure spending to enhance information technology, cybersecurity, and other information systems. Secondly, a reliance on construction and real estate loans means investors expect profit growth to be depressed for a while. However, the company has a long history of prudent loan originations and a strong Tier 1 capital ratio near 14% that will stand it in good stead if times get rougher.

Probably 2020 isn’t going to be a great year for OZK—or most banks for that matter, but I expect the company to bounce back in 2021.

Where I could be wrong:  The pandemic goes on beyond 2020 and the economy continues to be shut down, while construction loans continue to underperform.

Bottom Line:  Bank OZK is a well-run and steadily growing bank, with the cheapest valuation it’s seen in a long time. If the economy begins to recover, I think the market will recognize OZK’s “plain vanilla” attractions.

Prior “Signals”