Bank Bets: Fulton, Citizens & Lazard

07/18/2016 10:00 am EST

Focus: FINANCIALS

Doug Hughes

Editor, BankNewsLetter.com

Doug Hughes focuses on smaller cap banking and financial stocks; here, the editor of Bank Newsletter looks at two regional banking stocks and an asset management firm — each offering value and upside potential.

Steve Halpern:  Our special guest today is Doug Hughes, editor of Bank Newsletter.  How are you doing today Doug?

Doug Hughes:  Great, how you doing Steve?

Steve Halpern:  Good, thanks for taking the time.  You've been a long-standing expert in small and regional bank stocks; could you explain some of the overall benefits you see in this market niche relative to those who follow the larger financial firms?

Doug Hughes:  The small banks tend to be more nimble and meet very small/medium businesses in their local communities much faster decisions they can make on their loans.  That's what developers, businessmen want, and with the big banks you're under so much scrutiny, all the regulations, it's a little tougher for them.

Steve Halpern:  Now can you briefly walk us through some of the most important factors you consider when assessing the investment value of a small bank stock?

Doug Hughes:  Sure, Steve.  First, obviously we always love asset quality, making sure the bank has very few bad loans, the people running it usually goes hand-in-hand.  

If they're very smart, usually there are very few bad loans, and then third, we like an affluent area where there are people with some money, usually the money areas get the bigger premiums and takeover candidates and that's generally what we're looking for.  

We're always looking for a takeover and somebody that has growing earnings, growing dividends, and great asset quality.

Steve Halpern:  Now one specific regional thing that you favor is Fulton Financial (FULT).  Where do they operate and what makes this an attractive situation?

Doug Hughes:  Their headquartered in Lancaster, PA.  They're a large bank over 250 offices throughout Pennsylvania and Maryland.  The bank's just been around almost 135 years.  

They've done a couple of acquisitions, nothing in a long time, and it just seems like the management's setting up there to sell.  

The premium franchise trading the tangible book's around nine, usually a bank like this would sell for about two times tangible book or around $18 a share. I think it's currently trading at $13 even, pays nice 3% cash dividends.

The bank is usually buying back stock, insiders usually buy stock, just a premier franchise, a very large bank; and we just had five bank deals last week alone, which is the most, honestly, that I can recall since 2002.

So it looks like with the Fed easing up on these stock buybacks and easing up a little bit on larger deals, we're going to see a wave of mergers this year and next I think.

Steve Halpern:  Now another regional banking firm that you favor is Citizens Holding (CIZN), and they operate in Mississippi; what's the story behind this recommendation?

Doug Hughes:  Now here it's a much smaller bank, around a billion dollars, 23 locations, headquartered in Philadelphia, Mississippi.  

Insiders own a little over 20%, again, great asset quality, seasoned management team that's been there forever, most of the guys have been there over 30 years and I just think they're ready to retire.  

They haven't grown the bank too much lately, but with their franchise footprint and no bad loans and insiders owning this much stock, they're going to want to get paid one day.  

This one yields 4.5%, so you're definitely getting paid to wait, their book value is almost $19 a share and with the bank trading at 21 and change, it's worth at least $30 a share in a deal.

So you have very minimal downside and 50% upside, it's just a great opportunity to get a great franchise, and it could be sold tomorrow or it could not be sold for five years, but just a great risk-reward ratio.

Steve Halpern:  Now in line with that, when you recommend stocks as takeover targets, I assume these are companies that you're also comfortable holding if a takeover doesn't occur?

Doug Hughes:  Of course, all the banks we recommend normally pay 3% or higher cash dividends, normally they're all trading close to book, under book, a little bit over book, you know, instead of trading it two times book.

So usually the downside is very limited and, again, the upside can be only 10% sometimes or it could be 100%; it really depends on the bank and the timing of when you buy the stock.  

With all the bank stocks getting hit last week, there were some great opportunities, a lot of them have moved up, but again, there's always opportunities in the market, you've got to be patient and buy at the right times.

Steve Halpern:  Now in addition to the more traditional regional bank stocks that you cover, you're also bullish on a firm called Lazard (LAZ), which is a financial advisory and asset management firm.  First, could you give our listeners some background on this company?

Doug Hughes:  Sure, this is similar to Oppenheimer (OPY), which we've liked for many years, and a money management is a great business.  This company does half their business in money management and a little more than half actually in making deals.  

They make a lot of big deals and they make a lot of money and with the interest rates staying low here or if they are going down it looks like, there's going to be a wave of mergers in all types of industries and this money management firm is going to benefit greatly.  

The stock got clobbered on the Brexit news last week, it dropped from $35 basically to $26, which is a 33% drop for basically no reason other than people thinking the environment's going to slow down.  

They pay over a 5% cash dividend, they have $10 a share in cash, and they should earn about $5 a share this year, which gives them a PE of under six; they could earn more and they could earn less, the earnings are quite volatile.

But over the last 10 years, they have averaged around $4 a share in earnings to $6 a share per year.  Last year, they earned over $7.50 a share, which, in this market, this is the cheapest stock I've ever seen in my entire lifetime basically.

Steve Halpern:  Now does this firm also fit your overall investment criteria of having a strong management and a strong financial position?

Doug Hughes:  As a money management firm, I would believe -- there could be no better firm.  Perhaps they'll even buy Oppenheimer, the one we've been recommending for years.  

It's a great fit. And money management businesses, they've just got to keep growing and growing to scale with the rates coming downhill, down lower and lower.

We think interest rates are going to drop another three-quarters of a point over the next 12 months, which is going to be a boon again for mergers.

Steve Halpern:  Again, our guest is Doug Hughes of Bank Newsletter.  Thank you so much for your time.

Doug Hughes:  You're welcome.  Have a great day Steve.

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