Is Rocket Companies Stock A Buy Or Sell After Recent Earnings? We're Bullish Into Low Expectations

Summary

• Rocket Companies reported its Q4 results which were up against difficult comps in the period last year.
• Despite rising interest rates, the company continues to benefit from the strong housing market and demand for mortgage loans.
• The stock looks interesting following a deep selloff considering what remains a positive long-term outlook supported by solid fundamentals.
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Rocket Companies, Inc. (NYSE:RKT) is the largest mortgage lender in the U.S. which has leveraged its leadership position into a variety of fintech businesses including diversified real estate services, personal finance, and used car loans. The company has benefited from the strong housing market since the start of the pandemic which has supported record growth and a climbing market share. The latest quarterly result was highlighted by continued momentum in loan originations as the core business although shares of RKT have been under pressure amid concerns of a potential slowdown into rising interest rates which is already impacting earnings. Still, we like the stock, viewing the recent selloff as helping to balance the valuation into low expectations. RKT is supported by overall solid fundamentals and a positive long-term outlook.

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How Was Rocket Companies' Earnings Report?

Rocket Companies reported its Q4 earnings on February 24th with a non-GAAP EPS of $0.32 which missed expectations by $0.05. Adjusted revenue of $2.44 billion was also slightly lower than the consensus estimate by $180 million, and down 45% year-over-year. The story here is that the Q4 period last year and the second half of 2020, in particular, were exceptionally strong defined by the early stages of the pandemic where sharply lower interest rates led to a surge of refinancing and home buying activity. This means that the boom for Rocket Companies in 2020 created a tough comparison period for 2021.

In our view, it's important to place these latest results in the context of a 2-year stacked basis against 2019 pre-pandemic levels to get a sense of the more normalized trends in the business which are solid. By this measure, total revenues this quarter were up 36% compared to Q4 2019. Similarly, while the full year 2021 total revenue at $12.9 billion was down 17.5% y/y, the result was up 155% compared to 2019.

Company IR

Most financial and operating metrics were up from 2019. Q4 closed loan origination volume at $76 billion was down 29% y/y, the level was still up 49% over Q4 2019. This quarter, management noted some Covid disruptions into December during the Omicron-variant wave that impacted client engagement. For the full year 2021, closed loan origination volume at $352 billion was up 10% y/y and 142% over 2019, reflecting the continued strength in the housing market.

On the other hand, the challenge has been maintaining the momentum in profitability from 2020. Adjusted EBITDA at $883 million was down 71% from the period last year but still managed to stay 19% above the Q4 2019 level. A key indicator for the company with the gain on sale margin at 2.8% in Q4 was lower from 4.4% in Q4 2020 and also below the 3.4% in Q4 2019. Part of this dynamic reflects the rise in interest rates from record lows, which have spiked higher more recently.

There is also an aspect where refinancing activity has slowed compared to 2020 when homeowners rushed to take advantage of the available rates. It's understood that refinancing is typically more profitable for mortgage lenders. Nevertheless, the 2021 net rate lock volume at $333.8 billion was just 1.4% lower over 2020 and still up 119% over 2019.

We can note the strength across the rest of the business. The "Amrock" segment which deals with title and real estate transaction services reached 1.1 million closings in 2021, up 7% y/y and more than double from 445k in 2019. The "Rocket Homes" group, as home listings and search site, facilitated more than 30,000 transactions, representing over $8 billion in transaction value.

The trends support the company's strategy of providing a seamless end-to-end consumer home buying experience which adds cross-selling opportunities to the core mortgage business. Separately, the Rocket Auto car marketplace gross merchandise value (GMV) more than doubled in 2021 with the company facilitating 15.4 million unit sales, up 64% y/y.

Company IR

Putting it all together, this earnings report was good considering the circumstances and despite officially missing the headline estimates. The company announced a special dividend distribution of $1.01 per share, which follows the $1.11 payout last year. Rocket Companies has also been active with stock buybacks. Since the 2020 IPO, the company has returned over $4.5 billion to shareholders.

All this is facilitated by a well-capitalized and solid balance sheet considering $9.1 billion in total liquidity which includes $2.1 billion in cash separate from availability to fund loan originations. This is against approximately $4.0 billion in long-term senior debt that is beyond the mortgage funding facilities.

What Is RKT Stock Price Forecast?

We mentioned that shares of RKT have been volatile, down by more than 25% over the past six months. In Q1 last year, RKT briefly traded as high as $41.00 per share considering a momentum-based spike from the earnings report that captured the bulk of the operating momentum that now represents the difficult comps. The weaker than expected results through the second half of 2021 have caused the stock to trend lower over the past several months.

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So what we've seen is this rolling back of optimism into the new headwinds. For context, the 30-year mortgage rate industry average is approaching 4% which is sharply higher from levels under 3% for much of last year. Even as the latest indicators suggest home prices are still climbing, reports of tight inventory and affordability issues now weighing on sentiment. All this as the Fed has signaled the start of a new rate hiking cycle, raising questions about how much momentum the housing market still has and what the demand for mortgages will look like through next year and beyond.

Data by YCharts

The good news is that Rocket Companies is a fundamentally stronger company than where it was in prior years. Its reported market share at 8.8% has climbed from 7.8% in 2020 and 5.0% back in 2018. The upside here is that the company is capturing a larger slice of the market even if margins are being pressured through rising rates. Management commented on these trends during the earnings conference call:

Looking ahead to Q1, despite a rise in mortgage rates at the beginning of 2022, we continue to see a robust mortgage market by historical standards. The median U.S. home value has increased 25% over the last two years, equating directly to larger loan sizes. In addition, demand from homebuyers remains strong, demonstrated by the record levels of verified approval letters we are providing at Rocket Mortgage, up 50% year-over-year in January.

Company IR

Putting it all together, we believe Rocket Companies is well-positioned to navigate the current market environment and continue growing its market share with a best-in-class platform. The attraction here is a nationally recognized brand, with a cohort of loyal customers and high retention rates representing a runway for future growth opportunities.

Is RKT Overvalued?

According to consensus estimates, even as 2022 revenue is forecast to fall 25% y/y along with a 49% drop in EPS, the key takeaway is that Rocket Companies remains profitable and generates significant cash flows. Looking ahead, the trend is for the operating environment to at least stabilize in 2023 and generate organic earnings growth over the long run.

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While the records from 2020 will be hard to beat in the near term, the upside here is that the stock price selloff may have already priced in the near-term challenges leading to an attractive valuation at the current level. We see upside to the consensus estimates as part of the bullish case for the stock with a sense that the market may be a bit too pessimistic. The metrics we're looking at are between a forward P/E of 12x on the current consensus 2022 EPS as well as an 8.3x EV to forward EBITDA ratio for an industry leader that benefits with scale and remains a growth stock. In our view, RKT is fundamentally undervalued.

Data by YCharts

Considering Rocket Companies' online fintech business model and scale, there are not many other "pure-plays" on residential mortgage lenders. Other names in the category include more traditional banks and credit institutions that also offer home mortgages as well as other types of lending including on the commercial side or wholesale side.

We view RKT as generally following the trends in the housing market tech stocks which we include Zillow Group, Inc. (Z), Redfin Corp. (RDFN), Opendoor Technologies Inc. (OPEN), and even the broker platform eXp World Holdings (EXPI) that capture the broader sentiment in housing. While these companies have key differences and technically operate in different segments, real estate metrics like housing prices, industry-wide mortgage applications, and monthly existing home sales are the key metrics to watch. Rocket Companies stands out by its strong financials and efforts at diversification beyond mortgages.

Is RKT Stock A Buy, Sell, Or Hold?

We rate shares of RKT as a buy with a price target of $17.50 for the year ahead representing a forward P/E of 15x on the current consensus 2022 EPS. We believe the company will ultimately outperform expectations, benefiting from a stronger than expected housing market and demand for mortgages overall. Even into climbing interest rates, a resilient labor market in the U.S., along with high demand for homes supports a positive operating tailwind.

To be clear, there are plenty of risks to consider and the current market environment remains delicate. The ongoing Ukraine-Russia conflict has added a new layer of uncertainty with a very real possibility that the situation could escalate opening the door for the global macro downside. Weaker than expected economic growth and consumer spending in the U.S. can further pressure shares of RKT. Over the next few quarters, monitoring points for the stock include the gain on sale margin and net rate lock volume as a measure of the underlying health in the operation.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in RKT over the next 72 hours. 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.