Some Good Signs Here, but Wait on It

 | Dec 29, 2012 | 1:30 PM EST  | Comments
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Julian Inclan, a member of the Oriental Financial Group (OFG) board of directors, bought 5,000 shares of the company's stock in recent weeks at an average price of $12.93 per share, according to a filing with the Securities and Exchange Commission. Inclan now owns close to 100,000 shares, with this latest purchase having increased his holdings by a moderate percentage. Our database of insider-trading filings shows that Inclan bought preferred stock in early November of this year.

Several other insiders at Oriental Financial have bought both common and preferred stock in the last two months. For example, CEO Rafael Fernandez has made a number of small purchases, and CFO Gamesh Kumar reported buying about 2,600 shares earlier this month.

Consensus insider purchases, in our view, are particularly important to watch because they indicate that multiple insiders are confident enough that the stock price will rise that they are willing to ignore the benefits of diversification.

Oriental Financial, whose headquarters and primary operations are in Puerto Rico, is a bank and wealth-management company with $600 million in market capitalization and more than $3 million in daily dollar volume. It has proposed acquiring the Puerto Rican operations of another bank was approved by federal and local regulators. The transaction was completed on Dec. 18, according to the company's 8-K filing with the SEC.

We generally worry about acquisitive companies, as mergers and acquisitions often destroy shareholder value. But, once again, it is a plus to see that company insiders are willing to put more of their own money in their stock.

Third-quarter net interest income was up 18% year over year, reversing a decline here in the first half of the year. But lower non-interest income, combined with higher non-interest expenses, caused flat earnings per share the prior year. So, before the addition of the new operations, Oriental Financial did not appear to have been performing particularly well.

The company does have some value characteristics. For example, it trades at a slight discount, with a price-to-book ratio of 0.9. Wall Street's consensus is for $1.48 in earnings per share in 2013, implying a forward price-earnings ratio of 9; this is counting on quite a bit of improvement in the financials as a result of the acquisition. Per-share earnings of $0.80 are expected for 2012, which anticipates strong outperformance vs. the prior year.

If the bank does meet expectations, it will likely prove to be undervalued at such a low multiple -- and that is probably why the insiders are buying: It's reasonable to assume they believe the sell side has got it right, and that markets are not fully granting the company the benefits of the recent acquisition.

The optimism of company insiders is countered by some pessimism in the market. According to the most recent data, 13% of outstanding shares of Oriental Financial stock were being held short. In addition, the bank (like many other banks) is highly leveraged, with $2.2 billion in net debt.

We think that it would be best to wait for a quarter or two of results from the combined company, because the odds are generally against M&A benefitting shareholders. However, the valuation is low enough that a successful integration, allowing the company to meet analyst targets, could result in a good value opportunity for small-cap investors.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider OFG to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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