2 September 2016

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With a potential rate hike looming, bank stocks are back in the spotlight. Bank of the Ozarks, Inc is a banking counter that has fallen out of favor with the market over the past nine months. However, it may be time to consider the counter, both as an interest rate play and for slightly defensive exposure to the financial sector.

 

Background

Bank of the Ozarks is headquartered in Arkansas and has 170 branches in nine states. The bank offers commercial and retail banking services. The bank has been run by the same CEO and major shareholder George Gleason since 1979. Over the past 10 years, the bank has grown both organically and through a series of acquisitions.

 

Bank of the Ozarks has won a string of awards over the last six years and is well known as a very well run company.

 

After reaching an all-time high in December 2015, the share price has been under pressure.

 

In May, famed short seller Carson Block publicly announced he was shorting the share. While this was followed by some selling, there was no follow through. The market has, for the most part, dismissed Block’s concerns about OZRK’s loan exposure to the construction industry.

 

The growth opportunity

OZRK offers growth in the form of its competitive position relative to larger rivals, and those in its own size category:

• The Fed has indicated a high likelihood of an interest rate increase later in the year. This is seen as positive for bank shares, especially if it leads to increased lending in anticipation of higher rates.

• Bank of the Ozarks was named the top performing bank in its size category by Bank Director magazine. This is a solid business.

• OZRK is the highest quality counter in its size category, while still offering the potential growth that larger rivals find difficult to achieve.

• A number of analysts have upgraded the stock, with price targets between $47 and $51.

• The short float is around 10%, which could help underpin a rally for the share.

 

 

The defensive position

OZRK also offers several defensive qualities, which will be important if equity markets encounter difficulty:

• The price to book ratio is quite high relative to some competitors. However, the valuation is backed by solid and consistent earnings growth, which is more likely to be sustainable relative to its larger peers. Most other small banks are showing far lower earnings growth.

• The owner-manager culture and low staff turnover add to the defensive nature of the share.

• OZRK has built up quality earnings. Equity markets are showing decreasing earnings growth, which is likely to result in a flight to counters with quality earnings.

• Even if interest rates do not rise, the bond market offers little upside. Investors have therefore been forced to look to stable earnings streams as an alternative. OZRK offers a 1.6% dividend yield.

• The possibility of being acquired offers a strong underpin to the share price

 

 

The Technical Picture

Technically the stock has looked weak all year, falling 35 percent from its all-time high in December. The picture is starting to look more positive now. Firstly, the share fell below $35 three times but failed to follow through on each occasion. This has created a strong support level at $35. Secondly, the price has now broken the most obvious resistance trendline.

 

The rallies in April and June have given potential sellers plenty of opportunity to offload their stock. Current holders are therefore likely to be maintaining a longer term view.

 

Risks

No share is without risks. These are some of the risks to a long position in the counter:

• Resistance may be encountered around $42 This is where the  200-day moving average is encountered and is also the and peak of July rally.

• The banking sector always carries a certain level of uncertainty.

• OZRK is exposed to the construction sector, which may encounter difficulties.

• If the $35 level is breached, it will indicate that the market does not see value in the counter.

 

Strategy

• The share price is currently retesting the trendline it broke last week. Any sign of a slowdown in selling volume will offer a great opportunity to open a long position.

• In the event of the share retesting $35, a rejection of support will offer an even better entry point.

• In either case, a stop loss of $35 would be prudent.

• In the event of missing an entry below $39, the share, the best entry would be a break of $42, above which the price is likely to accelerate.

• $47 and $51 are the obvious profit taking levels in the medium term. However, the counter may be worth holding for longer, and for bigger targets.