Put The Baby Back In The Bath Water

| About: MidSouth Bancorp, (MSL)

Summary

Established over 30 years ago, MSL has consistently paid dividends since 1996, including dividend hikes even through the financial crisis.

High energy exposure has caused concerns, but insiders have picked up buying at these prices.

Get paid over 5% per annum, with great reward potential for capital appreciation.

The recent energy and commodity decline has made opportunities abound in the equity markets. In most cases, any name with exposure to the sector has been thrown out with the bath water. MidSouth Bancorp (NYSEMKT:MSL) is an excellent example. In its previous filings, it noted that roughly 20% of its loans have some direct or indirect exposure to the energy sector, specifically oil and gas. The exact direct exposure is roughly half that. It has greatly impacted return on equity in the last twelve months, which could be cause for concern. ROE has fallen from over 12% to currently less than 8%. The stock yields 5% in dividends, which it currently has no issue paying. Its dividend history has remained pretty solid, never halting payments since 1996. In January of 2012, payout ratios exceeded 80%. However, rates now rest under 40%, though payouts are on the rise over the last year since it bottomed in the low 20%. So for all this volatility, you must be expecting a significant exposure to the energy space.

[As of] December 31, 2014, one industry segment concentration, the oil and gas industry, aggregated more than 10% of our loan portfolio. Our exposure in the oil and gas industry, including related service and manufacturing industries, totaled approximately $265.0 million, or 20.6% of total loans.

From the 2014 Annual Report

Since December 31, 2014, the stock has slid 60%. From its 2014 high, the stock has lost roughly two-thirds of its value. Now, a 20% indirect exposure to the energy could be alarming. However, we must look deeper into the potential effects of capital structure from a boost of loan losses. Of course, if 100% of these loans defaulted, it would be troubling. But is this a realistic expectation? More so, what are the insiders doing, who I believe would clearly have more knowledge as to the potential for customer defaults?

Put simply, they are buying. Insider buying does not provide any robust knowledge historically to stock performance. While there are an enormous amount of reasons for an insider to sell, there is only one reason that executives would buy: they believe it's cheap. The table below shows the insider transactions for 2016.

Insider Trading

Relationship

Date

Transaction

Cost

#Shares

Value ($)

#Shares Total

SEC Form 4

LEMOINE TIM

Director

Feb. 04

Buy

8.22

1,300

10,686

29,560

Feb. 05 10:11 AM

LEMOINE TIM

Director

Feb. 03

Buy

7.80

770

6,006

2,347

Feb. 04 10:16 AM

LEMOINE TIM

Director

Feb. 03

Buy

7.49

8,620

64,564

28,260

Feb. 04 10:16 AM

PUMPELLY R GLENN

Director

Feb. 01

Buy

7.93

10,000

79,300

90,473

Feb. 01 06:10 PM

Hargroder Andrew G

Director

Feb. 01

Buy

8.00

2,500

20,000

131,617

Feb. 01 06:02 PM

CHARBONNET WILL G

Chairman of the Board

Jan. 29

Buy

7.68

10,000

76,800

114,446

Feb. 01 05:45 PM

SIMMONS WILLIAM M

Director

Jan. 29

Buy

7.72

500

3,860

4,650

Feb. 01 05:30 PM

SIMMONS WILLIAM M

Director

Jan. 29

Buy

7.62

1,000

7,620

173,940

Feb. 01 05:30 PM

Click to enlarge

Most notably, the Chairman has upped his stake by almost 10%. Some of these shares are commingled among their spouses, as well as in the form of deferred compensation. But the thesis is the same; clearly insiders are bullish at these prices, buying in a range from $7.49 to $8.22.

Why is their purchasing so important? Well, it is directly aligning shareholder interests with the executives'. And why is this important? If MidSouth gets into severe capitalization issues, which I believe is the true concern given the one-fifth exposure to energy, it might be forced to issue stock, further diluting shareholders at already record low prices. Do you think that management sees this as a high likelihood if they're in there buying shares?

At these prices, the dividend yield has jumped to 5%, which is a pretty decent return to immediately realize. The dividends may have to be cut if problems persist; however, capital structure seems to be the real issue moving forward, which is alleviated by insiders buying shares. Cutting a dividend will not help capital issues, which can really only be remedied by forcing the market to absorb a stock issuance. After share prices recovered from the financial crisis, MSL was able to slap shareholders with massive dilution to save the bank's capital concerns. MidSouth increased outstanding shares by 50%. I do not see this as a likely outcome given management's actions. It seems the market is punishing the company for having energy exposure, which is most likely overblown.

Free cash flow yields are at the highest levels seen since the company has been public, coming in at an impressive 32%. Yes, these will go down assuming some more loan losses occur, so we would expect to see high levels. The company's price to sales ratio has also never been lower, now trading at 0.838. Again, I would expect revenues to slightly decline as well, which is fine given the 66% drop in stock price already observed.

I have a good friend who recently purchased a small town bank with $20m in assets for $1.25m. He stated that he believes he can get the company to yield a 4% return on assets, once improved. At that assumption, he paid a price to sales premium of 1.5, assuming $0.8m revenues. I must remind you, this is for a privately held, small town bank. Maybe he overpaid. Or, maybe MSL is on sale. He paid $0.0625 for every asset on its books, where MSL is trading near $0.06 even. I'm actually only talking about net loans for MSL's case. If you use total assets, MSL is trading at less than $0.04 per dollar of assets. Now, is this all anecdotal evidence? Of course it is. But, when looking at MSL, I can get 5% preferable tax treatment pay-outs in the form of dividends from a bank that I paid almost half the price for current revenues. His family is well established in the banking industry, and I believe it to be a good fit for their situation and sure to be a success in the long haul. But as for my situation, I enjoy knowing that I can liquidate my investment in the next few years after I see some capital appreciation. Seeing the insiders buying at these levels only helps me feel more confident knowing they're aligning their interests further with mine.

Disclosure: I am/we are long MSL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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