Equity Research July 14, 2006 Scott A. Jaggers, CFA www.zacks.com 155 North Wacker Drive Chicago, IL 60606 Bank of the Ozarks, Inc. (OZRK-NSDQ) Current Recommendation Hold Prior Recommendation Sell Date of Last Change 05/23/2006 Current Price (07/13/06) $30.02 Six-Month Target Price $32.00 SUMMARY DATA 52-Week High $38.42 52-Week Low $30.02 One-Year Return (%) -6.72 Beta 0.42 Average Daily Volume (sh) 72,131 Shares Outstanding (mil) 17 Market Capitalization ($mil) $502 Short Interest Ratio (days) 54.09 Institutional Ownership (%) 62 Insider Ownership (%) 32 Annual Cash Dividend $0.40 Dividend Yield (%) 1.33 5-Yr. Historical Growth Rates Sales (%) 17.6 Earnings Per Share (%) 32.8 Dividend (%) 31.7 P/E using TTM EPS 15.4 P/E using 2006 Estimate 15.1 P/E using 2007 Estimate 12.7 Zacks Rank 4 OUTLOOK OZRK hosted a conference call this morning after its earnings release last night. Nothing in the call changed our view relative to what we discussed in our Note. Management did clarify that there have been no bonus accruals so far in 2006. The quarter was solid (EPS was $0.02 better than our estimate), but not quite as strong as the headline implies. NII was below our projections, owing to a 23 bp decrease in NIM. The surprise came on the expense side, as expected growth from new branches and new hires was not evident. Our near-term estimates are little-changed, while 07 is coming down marginally. Our price target is falling in line with lower industry multiples overall. We view the $0.40 annual dividend as secure. Risk Level Below Avg. Type of Stock Small-Growth Industry Banks-Southeast Zacks Rank in Industry 82 of 105 ZACKS ESTIMATES Revenue (in millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2004 18 A 20 A 21 A 20 A 79 A 2005 21 A 22 A 23 A 23 A 88 A 2006 24 A 23 A 24 E 25 E 96 E 2007 25 E 28 E 29 E 31 E 114 E Earnings Per Share (EPS is operating earnings before non recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2004 $0.36 A $0.38 A $0.40 A $0.42 A $1.56 A 2005 $0.44 A $0.46 A $0.48 A $0.50 A $1.88 A 2006 $0.50 A $0.47 A $0.49 E $0.53 E $1.99 E 2007 $0.53 E $0.57 E $0.61 E $0.65 E $2.36 E Zacks Projected EPS Growth Rate - Next 5 Years % 14 Consensus Projected EPS Growth - Next 5 Years % Copyright 2006, Zacks Investment Research. All Rights Reserved.
OVERVIEW Headquartered in Little Rock, AR, Bank of the Ozarks, Inc. (OZRK) is the holding company for statechartered Bank of the Ozarks. OZRK provides a range of retail and commercial banking services through 56 full-service offices in Arkansas and three in Texas, plus three loan production offices in Arkansas and North Carolina. OZRK continues to grow primarily through a de novo branching strategy which it initiated in 1994. Expansion plans for 2006 include a record 12 new offices. Management is clearly focused on growth, but with an eye toward profitability. OZRK operates a fairly traditional banking model, deriving most of its revenue (79% in 2005) from spread-based sources. The loan portfolio is somewhat focused on real estate (82% at March 31), with the balance made up primarily of commercial / industrial, agricultural and consumer loans. The securities portfolio has been relatively steady at 25-30% of average earning assets in recent years (30% in Q2), which is a bit higher than necessary in our view, and helps explain the company s high returns. Noninterest-bearing and other low-cost deposits funded 33% of average earning assets in Q2, with time deposits and borrowing funding 51% and 18%, respectively. At June 30, OZRK had $2.4 billion in assets, $1.6 Bn in loans and leases, and $1.8 Bn in deposits. RECENT NEWS OZRK announced 2 nd quarter results on July 13. Net income was $7.9 million, or $0.47 per diluted share (two cents better than our estimate and a penny ahead of consensus). The quarter was relatively solid in our view, but not quite as strong as the headline implies. Management had seemed to imply previously that expense growth would be high, and we had attempted to adjust our forecast accordingly. In the end, though, both compensation and non-comp expenses were down sequentially, more in line with where we had been previously. Much of this year s spending is discretionary and lumpy, based on new branches and new hires. Our thinking at this time is that related spending has likely just been postponed, not eliminated, and we expect expense growth in each of the next two quarters. As for revenue, net interest income came in below our projections, rising only 1.7% sequentially, as a 7.4% increase in average loans was significantly offset by a 23 bp decrease in the margin (to 3.61%). Non-interest income was basically in line, as was the provision. Our near-term estimates are virtually unchanged at this time, while 07 figures are coming down slightly. Tax-equivalent net interest income increased by 1.7% sequentially (6.8% year-on-year) to $19.1 Mn, as 7.0% growth in average earning assets and a longer quarter were partially offset by a 23 bp drop in net interest margin (to 3.61%). Further margin deterioration remains a possibility, though the magnitude should be less than in recent quarters (although we said the same thing last quarter). Average loans and leases grew a strong 7.4% sequentially following their weakest quarterly showing in several years in Q1. Average deposits were up 9.3% sequentially (25.0% year-on-year), including nearly 8.5% growth in low-cost deposits. ROA and ROE fell noticeably on a GAAP basis, after last quarter s shortfalls were masked by huge securities gains. Credit quality remained outstanding, with net charge-offs annualizing at 0.09% in Q2 (down 1 bp sequentially) and non-performing loans checking in at 0.18% of total loans (down 6 bps). Capital remained solid, though tangible equity took a bit of a nosedive, falling 63 bps sequentially 5.9% of tangible assets. No detail was provided, but the culprit was most likely unrealized securities losses (the portfolio remains large at 30% of average earning assets in Q2). VALUATION OZRK currently trades at 14.4 times the consensus forward estimate (versus 15.9x at the time of our last full report), in line with the peer group median (vs. a 5% premium at that time). The premium is higher Zacks Investment Research Page 2 www.zacks.com
versus its southeastern peers, which have a lower expected growth rate (8.0% vs. 10%) and now trade at a median of 13.8 times forward estimates (vs. 14.3 x in mid-april). On a price-to-book basis, the shares trade at a 42% premium to the peer median, vs. a 61% premium previously. Current pricing continues to look interesting on a P/E-to-growth (PEG) basis, using the consensus forward estimate and our own long-term growth rate (no consensus LTGR is currently available). OZRK s P/E-to-growth (PEG) ratio on this basis is 1.03, a 29% discount to the 1.45 median for the peer group (vs. a 25% discount previously). On a price-to-book basis, however, the 42% premium looks fair given an ROE 55% above median (and falling). The quantitative Zacks Rank for OZRK is currently 4 (down from 3 on April 12), indicating some likelihood for downward pressure on the shares over the near term. Short interest remains extremely high at 54.1 days, though down from 59.5 days previously. Industry Comparables (small-cap banks) P/E using trailing 12 mo EPS P/E using 4 qtr Est 5 yr Avg trailing P/E Return on Equity Return on Assets Price/ Book Next 3-5 Yr Est EPS Gr rate Div Yield OZRK 15.4 14.4 17.1 22.3 1.57 3.28 1.3 median 16.2 14.4 16.7 14.4 1.33 2.31 10.0 2.0 average 16.9 14.8 17.0 15.7 1.34 2.44 11.3 2.0 high 25.0 21.1 21.4 26.8 2.12 4.23 18.5 4.9 low 10.1 7.9 13.9 6.6 0.72 1.44 6.0 ----- Our new $32 target assumes that the shares will trade at 3.34 projected book value six months out, which also equates to 13.6 times our own forward estimate at that time. Combined the dividend, this equates to a 7.3% expected total return over the period. BULL STORY OZRK remains a growth story among the banking universe, generating consistent growth in both revenue and earnings in recent years. The majority of this growth has come from its de novo branching strategy (embarked on in 1994). OZRK opened six new branches in 2005, expanded another, and replaced two temporary facilities with permanent ones. Management intends to continue this strategy in 2006, adding as many as 12 new offices (and replacing two more temporary facilities), three of which have been opened year-to-date. De novo branching is often an expensive way to grow, but OZRK has managed to grow tremendously in recent years while improving the firm s cost structure at the same time, with the efficiency ratio reaching a new record as recently as Q4. Management continues to reiterate its focus on profitable growth. This is often a stated goal, but OZRK remains a fairly rare example of demonstrable success. ROA and ROE remain well ahead of the peer medians, at roughly 1.55% and 22% over the last 12 months, respectively. Both loan growth and deposit growth improved significantly in Q2, with average balances up 23.2% and 25%, respectively, year-over-year. As was noted on the Q4 call, deposit strategy has turned more aggressive, and we might expect deposit growth rates in the mid-teens to low 20s (matching their general expectation for loan growth), with some related pressure on the margin. Variable rate loans remain a growing component of OZRK s portfolio, continuing to improve its rate positioning at the margin. Credit quality remains solid, with non-performing loans representing 0.18% of total loans at June 30, and an allowance equating to 5.5 times NPAs and 1.12% of total loans. Zacks Investment Research Page 3 www.zacks.com
BEAR STORY We believe that P/B generally acts as a constraining factor for the shares (typically among the highest P/B of all the small-cap banks we track), which could easily trade higher on a PEG basis. Given the lower ROE in Q2 and probably throughout 2006, we think that the decline in P/B was justified, though we expect it to be more stable going forward. Margin compression also remains a concern (for all the banks) in the near future. Compression continued in Q2, exceeding even the magnitude of the Q1 decline, with NIM falling another 23 bps sequentially to 3.61%. The primary culprit was again management s deposit initiative, as a number of deposit products were re-priced in late January. A flat yield curve and stiff competition certainly did not help. Further margin deterioration remains a possibility, though the magnitude should be less than in recent quarters (although we said the same thing last quarter). Concentration risk is also significant to OZRK. One example of this is in credit risk. OZRK saw significant deterioration in credit quality in late 2004 (with non-performing loans more than doubling as a percent of total loans during the course of one quarter) on the back of a single credit relationship. While not indicative of a downward trend, it highlights an aspect of concentration risk that exists in smaller institutions. OZRK faces other forms of concentration risk, in our view, with 80% of revenue from net interest income, 80% of loans based on real estate, and 95% of branches in Arkansas. PROJECTED INCOME STATEMENT & BALANCE SHEET Bank of the Ozarks, Inc. Income Statement and Balance Sheet (Dollars in millions, except EPS data) 12/02 12/03 12/04 12/05 12/06 E 12/07 E Net interest income 40 49 61 69 74 90 Non-interest income 12 17 18 19 22 23 Net revenue (not FTE) 52 66 79 88 96 114 Loan loss provisions 4 4 3 2 3 5 Non-interest expense 25 32 38 40 45 51 Income taxes & other 9 10 12 14 15 18 Zacks adjusted income before NRI 14 20 26 31 34 40 GAAP net income 14 20 26 31 34 40 Diluted EPS before NRI 0.92 1.24 1.56 1.88 1.99 2.36 Reported EPS 0.92 1.24 1.56 1.88 1.99 2.36 Loans & leases 718 909 1,135 1,371 1,730 2,080 Investment securities 232 364 435 574 740 910 Total assets 1,036 1,387 1,727 2,135 2,710 3,270 Deposits 790 1,062 1,380 1,592 2,050 2,540 Other liabilities 173 226 226 394 500 540 Shareholders' equity 73 98 121 149 160 190 Zacks Investment Research Page 4 www.zacks.com
HISTORICAL ZACKS RECOMMENDATIONS DISCLOSURES The analysts contributing to this report do not hold any shares of OZRK. Zacks EPS and revenue forecasts are not consensus forecasts. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Buy- Zacks expects that the subject company will outperform the broader U.S. equity market over the next one to two quarters. Hold- Zacks expects that the company will perform in line with the broader U.S. equity market over the next one to two quarters. Sell- Zacks expects the company will under perform the broader U.S. Equity market over the next one to two quarters. The current distribution of Zacks Ratings is as follows on the 1128 companies covered: Buy- 21.5%, Hold- 73.9%, Sell 4.5%. Data is as of midnight on the business day immediately prior to this publication. Zacks Investment Research Page 5 www.zacks.com