Rising Star Buy: Franklin Financial

The latest selection for my Special Situations portfolio is a small-cap bank that has recently demutualized. That bank is Franklin Financial (Nasdaq: FRNK  ) , and it offers investors a fantastic way to play one of the classic special situations: a demutualization. So I'll be buying $1,000 of the stock on the next trading day.

The business
Franklin Financial operates Franklin Federal Savings Bank, located in the Richmond, Va., area. It offers the standard range of bank services. Following a demutualization and cash infusion, the bank returned to profitability in 2011, and has remained there over the last 12 months.

While return on equity is unimpressive -- just 1% over the last four quarters -- the thing to look at is book value. The company trades at 0.82 times tangible book value. So the upside here might not be huge, but it's real, and the downside is limited, unlike what we might find in other highly leveraged financial players, many of which engage in riskier activities and dubious accounting.

Company

Price/Tangible Book Value

Common Equity/Assets

Franklin Financial 0.82 24%
Bank of America (NYSE: BAC  ) 0.58 10%
Citigroup (NYSE: C  ) 0.55 9%
Wells Fargo (NYSE: WFC  ) 1.70 10%

Source: S&P Capital IQ.

Franklin Financial is cash-rich, with equity at 24% of assets, suggesting it is overcapitalized. And more important, there are clear catalysts in place to realize that value -- that's why I'm buying.

Why I'm buying
First, the company undertook a demutualization in early 2011. It switched from a mutual holding company and sold more than 12 million shares at $10 a pop as it became a publicly traded company. Overnight it doubled its tangible book value -- making shares a great value so long as the company survived. Demutualization is one of the classic special situations -- one that Peter Lynch took advantage of following the S&L crisis some 20 years ago. Many banks end up being acquired a few years after the demutualization, too.

Second, earlier this month the company announced a share-repurchase program that allows it to buy up to 5% of its outstanding stock through Oct. 31. That move should help increase tangible book value per share for remaining shareholders, since the company would likely buy below book. It's also a typical move in demutualizations, where overcapitalization leads to the company repurchasing shares.

Third, we also have an activist investor or two hunting around for value. Earlier this year, Lawrence Seidman filed a 13-D, indicating his activist intentions. In the filing, Seidman stated that the shares were undervalued -- they were around $13 then -- and that he had had "several conversations with management... concerning ways... to increase shareholder value" and will continue having these conversations. Stilwell Value, a well-known fund in this area of the market, also owns almost 1% of shares.

Risks and return
The risks here are typical for any bank -- bad underwriting and a poor economy that increases charge-offs -- with the added element of Franklin's geographic concentration in the Richmond area. But with such a high ratio of equity to assets and the catalysts I mentioned above, I expect this stock to appreciate to at least book value. If it can start to earn a reasonable return on equity, then it could rise above that, perhaps giving us as much as a 50% return from our price here.

So my Special Situations portfolio will buy $1,000 of the stock on the next trading day.

If you're looking for more great opportunities such as this, follow me on my discussion board and on Twitter (@TMFRoyal).

Jim Royal, Ph.D., does not own shares of any company mentioned. The Motley Fool owns shares of Citigroup and Bank of America. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1888807, ~/Articles/ArticleHandler.aspx, 12/20/2014 8:53:36 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement