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.