Hold: Rocket Companies Is Far From Its Doomsday

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Summary

  • Rocket Companies is the largest player in the mortgage realm, which has taken the lead in the market through its innovative tech-based approach.
  • The current macroeconomic climate threatens to bring mortgage financiers to their knees and has not left industry giants immune.
  • RKT took a heavy hit in the recent quarterly earnings, in terms of its loan origination, net profit, and adjusted EBITDA.
  • Despite the poor performance, valuation metrics still show positivity amongst the market in relation to RKT.

Destroyed Cityscape

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When times get hard, only the resilient survive. And that is exactly why I believe Rocket Companies, Inc. (NYSE:RKT) to be a hold. The stock is faced with, perhaps, what is its biggest challenge yet, and has suffered in its recent quarterly performance. However, I am confident that the stock is far from its doomsday and will come out victorious. Its position as a market leader and its next-gen tech advantage in an otherwise traditional industry give it a substantial safety cushion against these hard times.

Company Overview

Rocket Companies is a dynamic and tech-oriented Detroit-based real estate, mortgage, and e-commerce company, which offers several different services, through its various segments and product lines, to its clients and customers. Starting in the mortgage industry in the late 1980s, Rocket Companies has found its strength in the fintech domain, through which it has launched several business lines. These include the following areas:

  1. Digital real estate platforms;
  2. Home financing facilities;
  3. Digital lending platforms for unsecured loans;
  4. Auto purchase platforms;
  5. Digital sales and marketing services.

Given the fact that Rocket Companies has been the largest mortgage lender in the USA, it is also one whose movements are closely watched by market participants. The company has succeeded in acquiring the position of market leader by integrating digital and tech-oriented mechanisms into financing and mortgages. This gives the company a competitive edge over conventional players in the industry while allowing clients to remotely apply and check the status of their loan, at any given time.

By optimization through smart digital solutions, Rocket Companies succeeded in lowering overheads such as paperwork and eliminating other "middleman costs," leading the company to hold a reputation for providing efficient loans:

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Rocket Companies Presentation - May 2022

Market Overview

The present inflationary environment of economic fallout from the Covid-19 period, as well as a global slowdown in trade due to political tensions with Russia, is not the best time for one to be looking at the mortgage market. With the U.S. federal reserve bringing on unprecedented interest rate hikes to tackle substantial inflation levels, mortgage demand is falling heavily. In fact, as a result of the conditions, demand in April 2022 had come at an almost 50% fall from the level last year, due to the highest interest rates seen in nearly 12 years.

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Freddie Mac

As a result of this rapidly rising interest rate, rate and term refinances are virtually non-existent, which further adds to the financial pressure facing companies like RKT, which are already struggling against the plummet in demand. Analysts expect volatility to continue until the end of the year, and possibly into 2023, with a decline in interest rates not expected until at least 2024. It is important to note that housing demand by its nature cannot remain on its back indefinitely, and will see a surge once interest rates slide down to more favorable levels. However, the main red flag for investors looking toward the mortgage market is the uncertainty as to when such favorable economic conditions will re-emerge.

The strength, despite these challenges that Rocket Companies holds, is its market leadership, as well as its digital strategy, making it easily accessible for young individuals looking to buy their first home. The current environment is a difficult one for the market, which will likely see weaker players weeded out by more established giants. In this regard, Rocket Companies holds a significant advantage but would need to continue delivering innovative services that can best serve the market given current circumstances. The company would also need to ensure considerable cost-cutting to survive and maintain its leadership within the market.

Earnings and Performance

The first quarter of 2022 was perhaps the worst for the entire mortgage industry. During this period, Rocket Companies originated residential mortgage loans that totaled $54 billion, which was a hard 48% plummet from the prior year's comparable figure of $103.5 billion. Similarly, net income for the company had fallen by a staggering 64% from $2.8 billion to a mere $1 billion, in a single year. In terms of adjusted EBITDA, this figure is even more concerning falling from $2.5 billion to $0.5 billion. The company expects these figures to further plummet by Q2'2022:

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Rocket Companies Presentation - May 2022

Despite the bleak picture painted by the recent financials, as a result of crushing circumstances for the mortgage market, I believe there is some positivity within the details of the broader picture. For instance, loan servicing income had climbed up by 66.5% to $327.7 million. This was primarily a result of the increase in fair values of mortgage servicing rights. Moreover, expenses saw a decline, falling 5.2% to $1.6 billion, however, this too was a result of uncontrollable factors, as title production had substantially declined during the quarter.

It is evident that RKT's performance did not remain immune to the catastrophe descending upon the wider mortgage market, and hence the company would need to brace hard in the coming quarters, where it expects this plummet to continue. Being a market leader, and a tech-integrated mortgage provider, I do believe the company's financial sustainability is far from threatened. Its scalability remains unmatched across the U.S. market, allowing it to thrive in a complex market. Moreover, the historical gains RKT has enjoyed in the last decade, in terms of loan originations and market share likely give the company a significant safety cushion against macroeconomic pressures felt.

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Rocket Companies Presentation - May 2022

Valuation

The following table lists crucial price and valuation metrics of the four largest mortgage financing firms, in terms of market size:

Company

Market Cap

P/E

P/S

P/B

EPS (TTM)

EPS growth past 5 years

Return on Investment

Price

Rocket Companies, Inc.

15.9B

13.25

1.41

1.86

0.62

-33.60%

33.70%

8.76

UWM Holdings Corporation

6.1B

7.01

2.05

2.58

0.56

13.50%

4.05

Essent Group Ltd.

4.3B

5.45

4.12

1.04

7.43

20.40%

14.80%

42.59

Walker & Dunlop, Inc.

3.2B

12.05

2.4

2.06

8.46

17.90%

6.20%

106.08

Source: Finviz

In terms of P/E ratios, RKT stands with the highest figure, which hints at a slight overvaluation, which is in large part a result of its fall in net income in the recent quarter results. It also indicates that despite the broader circumstances faced, other similarly-sized stocks in the industry deliver higher earnings per share keeping price constant.

However, in terms of P/S ratio, Rocket Companies flips its position and is the best performing stock in comparison to its peers. Delivering the most revenue given its price, whilst simultaneously being the worst performer in terms of EPS, indicates that the company must heavily control its costs if it is to realize further growth.

The P/B ratio of Rocket Companies is significantly low at 1.86, indicating that, given the company's stock price, shareholders are entitled to a higher net asset value in the company, as opposed to other stocks. Given that this net asset value is that of the largest mortgage company in the US, this is an indicator of a pretty good deal. Similarly, the stock's ROI of 33.6% is substantially ahead of each of its competitors, indicating that despite the fall in adjusted EBITDA and net income, RKT is still the best value creator for investors.

Risks

In May 2022, Rocket Companies CEO, Jay Farner, had predicted an oncoming recession, as a result of which he stated the company is strategically working towards client refinancing. This points to a broader problem that RKT is faced with. The company's exposure to macroeconomic conditions is, to a large degree, uncoverable, given the nature of its business. The company has gone all in, in modernizing mortgage services, and becoming a market leader in the process, but despite its proactive and innovative strategies, loan origination, and hence investor value will always be dependent on external forces.

In the case of a recession, unemployment may rise, and disposable incomes may drop, which would directly lead to a further plummet in housing demand. This is especially concerning for Rocket Companies, as its financing facilities are set at variable rates, which could push clients towards defaulting, as opposed to those who have fixed-rate mortgages. The company states in its annual report (2021):

Borrowings under our financing facilities are at variable rates of interest, which also expose us to interest rate risk. If interest rates increase, our debt service obligations on certain of our variable-rate indebtedness will also increase. In the future, we may enter into interest rate swaps which involve the exchange of floating for fixed-rate interest payments to reduce interest rate volatility. However, we may not maintain interest rate swaps with respect to all of our variable-rate indebtedness, and any such swaps may not fully mitigate our interest rate risk, may prove disadvantageous, or may create additional risks.

Conclusion

Circumstances facing the mortgage market are at a low, as a result of which the financial performance of mortgage financers has taken a hit. Even Rocket Companies, which is the most significant player in the market was not immune to these shocks. However, as I have demonstrated above, I do believe that RKT is far from being pushed to financial unsustainability. Its performance and market share gains in recent years and its being a next-gen technological player in an otherwise traditional market gives it a substantial safety cushion to survive the oncoming hits. For this reason, I would be confident in saying that RKT is a hold.

This article was written by

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Stocks Telegraph is a dynamic team of financial market wizards with over 40 years of combined experience covering US stock markets. We hope to cover a wide range of stocks, asset classes, and investment strategies with a primary emphasis on what we perceive to be hidden gems scattered across the financial markets. Our articles integrate both top-down and bottom-up research methodologies, drawing upon detailed company-specific financials and macroeconomic analysis. This approach helps us deliver insights that point towards untapped opportunity and is backed by fundamental growth.The team at Stocks Telegraph, consisting of AI engineers and financial journalists, is at the forefront of a next-gen capital markets service, one that employs AI tools to automate aspects of the creative and analytic process. This encompasses all stages from initial research, and tracking stock data and news, to the creation of insightful reports.The brilliant minds at Stocks Telegraph are currently developing a robust AI tool to perform stock sentiment analysis through scanning digital content and news headlines. The goal of this tool is the prediction of stock movements by analyzing news headline tones and assessing market dynamics by utilizing data analytical functions.Our pipeline also includes plans to develop an automated tool capable of generating accessible earning insights, within minutes of official earning reports being published.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.

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