UK Edition
The Bank of England’s latest forecasts for the economy make for grim reading as the Old Lady of Threadneedle Street warns of a potentially lengthy recession. But they are just that: forecasts and nothing more.
There is no guarantee that they will be accurate and given the Bank’s appalling record on inflation of late the chances of them being right are probably pretty small. As a result, they form no part whatsoever of this column’s investment research process and the focus here remains unchanged, via the same multi-step process, which is designed to assess, in order, the following:
- A stock’s valuation, as that reveals what the market is already expecting and pricing in.
- Alternative outcomes and scenarios.
- The relative probability of those outcomes.
- The potential share price rises and falls offered by those alternative scenarios.
This takes us to OSB. First studied by this writer four years ago when the London market was still in a post‑Brexit funk as Theresa May tried to cobble together a workable treaty with the European Union, OSB has since generated a capital gain of more than 20pc and paid more than 60p a share in dividends for a total return of more than 40pc. The bank has also launched a £100m share buyback this year.
What caught our eye in 2018 was a lowly valuation (as a result of wider macroeconomic and market gloom), coupled with good operational performance and financial strength. The same combination exists today and, if anything, the valuation is even more depressed now than it was four years ago, thanks to the uncertain economic outlook.
August’s first‑half results were strong. Pre‑tax profits rose by 16pc as net interest margins on the loan book rose, helped by higher interest rates, and provisions for bad loans remained very modest indeed. A very low cost‑to‑income ratio of just 23pc supported both earnings and the eye‑catching 22pc return on equity figure. Last week’s third‑quarter update confirmed the encouraging picture, with further loan growth and no change in loan arrears.
The interims also reaffirmed OSB’s financial strength and its ability to weather an economic storm as the bank reported a “common equity tier one” ratio of 18.9pc, well ahead of regulatory requirements.
This is not to say that OSB comes without risks. Far from it. Any economic and house price downturn would be a test and hurt profitability, given the bank’s exposure to mortgages and smaller companies and its strong historic focus on buy‑to‑let.
But according to analysts’ consensus forecasts for 2022, the shares trade on barely five times earnings and offer a yield of almost 7pc.
Such a lowly rating and fat yield may be the market’s way to politely say it thinks the earnings forecasts are optimistic and that the outcome will be lower‑than‑expected profits, even though analysts are already forecasting a 13pc drop in earnings per share for 2023.
The valuation does also mean, however, that an economic and housing downturn is at least partly discounted by the shares’ 24pc decline since early August. The stock even trades at a discount to net asset value of 447p a share.
The Bank of England is probably right that hard times are upon us and it may even be right about the degree of the pain about to come. Britain’s economy, like so many others, had come to rely on cheap money, cheap energy and cheap labour. All three are becoming more expensive and could continue to do so, with inevitable consequences for households’ ability to save and consume on one hand, and corporations’ profits and margins on the other.
But even if Britain suffers a housing market collapse of epic proportions, and an equally severe surge in mortgage defaults, OSB appears to have the financial strength to come through it, and if such a set of circumstances were to present themselves it seems unlikely that either the Government or the monetary policy committee would sit idly by and do nothing.
OSB appears to offer a good combination of yield and contrarian value. Hold.
Questor says: hold
Ticker: OSB
Share price at close: 436.4p
Russ Mould is investment director at AJ Bell, the stockbroker
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