Plenty of Upside For TFS Financial, and I’m Buying More

I've been buying shares of TFS Financial (NASDAQ: TFSL  ) in my Special Situations portfolio for some time, and I finally saw the catalyst I had been waiting for: the bank cleared its memorandum of understanding (MOU) with federal regulators. That means that restrictions on buybacks no longer exist, and the company promptly announced a buyback for 6% of its outstanding shares. In addition, a dividend could be initiated. So I'll be adding to my already overweight position in the stock.

MOU is DOA
I'm very pleased to see regulators lift the MOU, and it means the company can begin aggressively buying back stock. The bank's first buyback authorization was for 5 million shares, about 6% of outstanding shares.

I expect the bank to make short work of this buyback, given its history and the repeated telegraphing of its intent to repurchase stock. Before the financial crisis, this same management team had repurchased nearly $300 million in stock in just two years at prices similar to today's. Buybacks at today's price are tremendously accretive to tangible book value per share.

There are about 80.1 million shares of TFS in the public market, and the company has $1,862 million in tangible book value. That translates into $23.23 per share of tangible book. The stock currently trades around $13 a stub. So the market values the company at about 56% of tangible book. That's remarkably cheap for a profitable bank.

What happens after this buyback? Let's assume they buy all the authorization at $13. Tangible book value goes down by $65 million and share count drops by 5 million. So now you have 75.1 million shares with a tangible book of $1,797 million. That translates into $23.93 in tangible book. Just by buying back stock, the company can rapidly compound tangible book value. I expect further buybacks to follow.

I expect the bank will power through this authorization, as it did with a much smaller authorization last year and as it did a few years ago with its near-$300 million buybacks. My calculations suggest that the company may have already purchased about 900,000 shares since the buyback went in force on April 9.

But there are other value drivers here, too. The bank is expanding its operations to have a more national footprint, using third party non-commissioned salespeople. And then there's the potential for a dividend, too. There are some legal hoops to jump through to make that a reality, but let's take a quick look at what the stock might yield if a dividend does happen.

Over the last four quarters, the bank has earned $60.8 million. If TFS paid out half that amount, it could offer a $0.40 annual dividend on 75.1 million shares. That would be about a 3% yield at today's price. Not bad, and it would attract dividend investors to the stock, likely pushing up the price. If earnings grew, the dividend could grow too, while the bank still maintained a modest payout ratio.

The real magic happens when you combine aggressive buybacks with a dividend. If TFS buys back another 6% of its stock, then it can increase its per-share dividend an equivalent amount without raising the absolute cost of the dividend. Buybacks remove shares that otherwise would have received a dividend.

The company reports earnings on April 24, and will hold its conference call on the 25th. I expect we'll hear a lot more from the company on its buyback plans then. I know many analysts will be happy to express their congratulations on the MOU being lifted. Recent conference calls have seen many analysts bemused by the persistence of the MOU in the face of sustained profitability and absurdly high capital levels at TFS Financial.

Foolish bottom line
My Special Situations portfolio will be buying $500 of this cheap and profitable bank, and will look to add more if the stock remains this cheap. That will add not quite a full percentage point to a position that already amounts to over 12% of the portfolio. I think the prospects for TFS for the next few years are tremendous.

Interested in TFS Financial or have another stock to share? Check out my discussion board or follow me on Twitter, @TMFRoyal.


Read/Post Comments (5) | Recommend This Article (8)

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.

  • Report this Comment On April 19, 2014, at 1:48 AM, Porchdog99 wrote:

    Public filings show there are about 300 million shares outstanding. Therefore, tangible book is actually about $6.20 per share. It trades for over 2x tangible book. You appear to be trying to apply a tangible book value based on the float. Please explain your rational.

  • Report this Comment On April 19, 2014, at 2:29 PM, grizzknerr wrote:

    In the same vein as Porchdog's comment I think a dividend is quite unlikely. Prior to Dodd-Frank, MHC institutions could pay a dividend to minority shareholders and easily waive paying that same dividend to the MHC-held shares. Today that dividend must be paid on all shares resulting in double taxation at the least plus slight dilution of current minority holders.. Indeed this is one of numerous reasons given by managements justifying the recent 2nd step conversions of Clifton Bancorp and Investors Bancorp. In Clifton's case the first quarter dividend was postponed to the post-conversion second quarter to avoid this problem. Since TFS Financial holds a vast majority of shares in the MHC pool, a dividend would actually be a shareholder unfriendly, not a sunshine and blue skies, move.

  • Report this Comment On April 21, 2014, at 11:00 AM, TMFRoyal wrote:

    Hi, Porchdog99,

    Those 300 shares are not all issued, however. The public finance sites get this wrong. The actual issued share count is around 80 million, since the MHC holds about 73.9%. So you can't ding the company for extra shares it hasn't issued. This is a quirk of the demutualization process.

    Jim

  • Report this Comment On April 21, 2014, at 11:03 AM, TMFRoyal wrote:

    Hi, grizzknerr,

    I understand that there are hoops to jump through to get a dividend to just the minority holders (ie the public shares) following new legislation. But at least one bank has gotten the dividend waiver from its MHC, as far as I've seen. So I agree with you here, and I'd rather they NOT pay a dividend if they can't get the waiver. And if they don't pay a dividend? Well, that can be more money for buybacks, which I'd prefer anyway.

    Jim

  • Report this Comment On April 29, 2014, at 8:23 PM, FrankoJames wrote:

    You should have purchased PNC a long time ago.

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