During this writer’s time as an equity analyst at a major investment bank, one of the best bits of the job was talking to smart clients, even if sometimes the client knew far more about what was going on and offered more value added than the standard slide deck that we used to push around.
One hedge fund client used to refer, quite seriously, to “price to brain damage,” when he came across a stock that was just too hard to call and felt that the potential upside on offer might not necessarily compensate for the time and effort to stay on top of it, even if the shares looked cheap – in fact, especially if they looked cheap, as he argued that was where potential pitfalls lay. OSB, a long-standing holding in this portfolio, may be just such a stock.
This is not to say the bank is badly run and or subjecting its shareholders to anything like the shambles suffered by investors in Silicon Valley Bank or Credit Suisse.
Not at all. OSB’s full-year results make that clear. Last year the bank, like many others (but not Credit Suisse) made record profits. It also grew its deposit base, generated a belting 21pc return on equity and maintained a strong capital base (as evidenced by its common equity tier 1 ratio of 18.3pc) with the result that management felt able to increase the dividend, offer a special dividend and launch a new £150m share buy-back programme to supplement the £100m returned to investors via this mechanism in 2022.
Indeed, last year’s interim, final and special dividends, plus the buyback, come to about £285m in total, or 14pc of the market capitalisation, which will no doubt appeal to income seekers.
Moreover, consensus analysts forecasts put the stock on a forward price to earnings ratio of a little more than five times and a dividend yield north of 7pc, based upon earnings per share (EPS) and dividend per share estimates for this year of 87p and 35p respectively.
The EPS estimate represents a slight dip from the 90.8p generated in 2022 to suggest analysts are not getting carried away. In addition, the £2bn market cap compares with shareholders’ equity of £2.2bn, so the shares come on a low PE, a fat yield and a discount to book value for good measure, to at least partly price in a deterioration in trading.
The FTSE 250 company is a specialist in buy-to-let, residential and commercial property mortgages, areas that markets are (rightly or wrongly) treating with greater suspicion as the banking sector wobble prompts fears of a slowdown in credit growth, tighter lending standards and, in turn, an economic slowdown.
In addition, the bank is predominantly funded by customer deposits, gathered via the Kent Reliance and Charter Savings Bank brands. This model works well and OSB passes the capital adequacy requirement at a breeze, so depositors have no need for concern and are likely to stay put. But right now, financial markets do not seem interested in listening to that either.
Instead, investors are either shunning the banking sector altogether or, if they are maintaining exposure, they are doing so via megabanks not challengers, and they are looking for broad-based, vanilla banking (retail and commercial) and not exposure to particular niches, no matter how carefully managed, and lucrative, it is. Investment banking exposure, not an issue with OSB (or Lloyds for that matter) is deeply out of favour too.
As such, OSB’s shares are unlikely to thrive in this environment, almost irrespective of how well run it is, how soundly financed it is and how cheap the equity might be.
Valuation needs a positive catalyst for it to be unlocked, and in the short term it is hard to see what that catalyst might be. This is the headache posed by OSB, through no fault of its own or that of management.
Income-seekers might like to stick around so they can bank the final dividend of 21.8p per share and 11.7p special payment, both of which are payable on May 17.
More risk-averse investors may wish to cut and run, especially as our initial study from just over four years ago leaves us with a near-40pc book profit and 68.7p a share in dividends (before the May payments), equivalent to a further 20pc return on the entry price. They can then keep OSB on their watchlist in case the shares are caught up in a wider market melee.
For now, discretion feels like the better part of valour.
Questor says: sell
Share price at close: 460.6p
Russ Mould is investment director at AJ Bell, the stockbroker
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