Rocket Firms: Don’t Purchase But

I wrote about Rocket Firms again on August 23 of final yr, when the inventory was at $17.57. On the time, I stated:

“I’d choose to take a position with extra concern within the valuation, so I counsel ready to see if Rocket could be purchased beneath $15. There must be no hurry – the chances are excessive that over the following yr or extra the information will worsen.”

Immediately the inventory is buying and selling at $8.80. By my math, that’s beneath $15. Time to purchase? Sorry, however I don’t suppose so. $7 could be a great entry level.

On this article I’ll evaluation what we all know and why which means Rocket ought to earn solely about $0.50 per share this yr and subsequent yr, and $1.00 in 2024.

What we all know – We will ignore “Rocket the Fintech”

Administration passionately pitches itself as a fintech. For instance, from its annual report:

“Rocket Firms is a fintech platform firm consisting of non-public finance and client expertise manufacturers. We leverage our expertise, information and extremely educated Rocket Cloud Pressure to supply purchasers with certainty all through life’s most complicated transactions…”

And:

“Rocket competes in a few of the largest, most complicated segments of the economic system, together with mortgage, actual property, auto, monetary providers and photo voltaic. Our markets stay extremely fragmented, and we’re positioned to realize market share by main the digital transformation of our industries.”

This sort of hype was useful to shares final yr, when traders clamored for disruptor tales, nonetheless unlikely. However disruptor tales are so over – see the inventory charts of Zillow (Z), SoFi (SOFI), Opendoor (OPEN), and so on.

I don’t understand how Rocket’s forays into actual property brokerage, automotive gross sales and private finance will end up. However the reality is that in the present day they’re tiny in comparison with Rocket’s mortgage banking enterprise, and will likely be so for a lot of, a few years. I have a tendency to fret that Rocket and its friends will spend extra money chasing these desires than they are going to ever earn. However the bills and revenues are rounding errors for a few years.

What we all know – the mortgage origination cycle has almost bottomed

My article final yr targeted on the understanding that mortgage originations would plummet from their $4.4 trillion annual tempo at the moment, as mortgage refinancing inevitably ended. Oddly sufficient, the inevitable occurred. The plunge in refinancing has introduced the Mortgage Bankers Affiliation’s (MBA’s) projected 2022 originations to $2.5 trillion, an almost 40% year-over-year decline.

However this chart exhibits that mortgage originations are close to backside:

Supply: Mortgage Bankers Affiliation (MBA)

Whereas there isn’t any development for the foreseeable future, at the very least the chance of one other sickening sharp decline is restricted. For instance, the $552 billion of residence buy originations Fannie Mae expects for this Q3 is 34% above the pre-COVID Q3 ’19 quantity, in keeping with residence worth will increase over that interval. And the $145 billion of refis Fannie expects for Q3 is definitely beneath the pre-COVID norm.

What we all know – the wanted provide shrinkage has begun

A 40% decline in demand clearly creates extra capability. That extra has taken a toll on Rocket’s mortgage origination revenue margin (in mortgage banker-speak, the “acquire on sale margin”), as this chart exhibits:

Supply: Rocket Firms monetary reviews

Returning to regular revenue margins requires a big decline in provide, which implies firing a number of mortgage bankers. That has begun occurring – even at Rocket! – as this partial record from site The Fact About Mortgage exhibits:

“Amerifirst House Mortgage layoffs in Kalamazoo, MI / Owners Monetary Group layoffs in Arizona / Costco Mortgage program not out there as of Could 1st, 2022 / U.S. Financial institution reduce 200 mortgage operations jobs / Mr. Cooper reduce roughly 250 jobs / Flagstar Financial institution reduce 20% of mortgage employees (420 jobs) / Rocket Mortgage providing buyouts to eight% of employees / Wells Fargo reducing unspecified variety of mortgage jobs / USAA Financial institution reduce 90+ mortgage jobs / PennyMac to chop 227 jobs in Agoura/Moorpark/Westlake, CA / Higher Mortgage to chop extra 3,000 jobs in United States and India / Redfin to accumulate Bay Fairness House Loans, 121 layoffs”

And so on.

I anticipate the availability shrinkage will likely be absolutely performed a yr from now.

What we all know – Rocket stands out from its friends

Mortgage banking is a miserably aggressive enterprise. There are literally thousands of mortgage lenders nationally, they usually all promote the identical core product, specifically a “conforming” (to Fannie Mae and Freddie Mac requirements) 30-year fastened price mortgage. Economists have a measure of trade competitiveness, known as the Herfindahl-Hirschman Index (HHI). The decrease the index, the extra aggressive the trade. By my calculation, the mortgage bankers’ HHI is barely above 100. Evaluate that to the U.S. auto making trade at a 1,100 HHI, and the web search enterprise at 5,500.

As one would anticipate, then, trade management is tenuous. Once I first beginning monitoring the trade within the mid-‘80s, the market share chief was Lomas & Nettleton. It went bankrupt in 1989. Then Wells Fargo and Countrywide Credit score battled for management, each reaching 20%+ market shares. Countrywide was staggered by the Nice Monetary Disaster (“GFC”), was purchased by Financial institution of America and ended up costing B of A tens of billions of {dollars}. Wells steadily shrank, to a 5% share in Q1.

In the meantime, Dan Gilbert based Rock Monetary in 1985. It pitched itself as an web play in the course of the late ‘90s, and bought purchased out by Intuit in 1999 and rebranded as Quicken Loans. Administration then purchased it again in 2002 after Intuit couldn’t abdomen the tip of a refinancing growth. Rocket survived the GFC as a result of it prevented the subprime lending that killed off a whole lot and even hundreds of friends, and bought rewarded by an ‘08/’09 refi growth. It grew steadily since to its grandeur in the present day.

How did it handle this success in such a tricky trade? A mix of a low rate of interest and credit score danger technique, and a deal with expertise to drive down working and advertising prices. Not mind science, however a stage of self-discipline that few friends can preserve.

What we now know – Rocket has a market share downside

What am I speaking about? Rocket has been a market share animal over time, because it proudly trumpeted in its newest earnings presentation:

However that’s not sufficient hype. Apparently, transfer over Amazon, make room for Rocket:

“Come on, Gordon, hop on the bandwagon. Rocket is rising to the moon.” I used to be truly shopping for this story till Rocket added this forecast to its Q1 earnings press launch:

“We anticipate the next ranges in Q2 2022: Closed mortgage quantity of between $35 billion and $40 billion.”

This suggests a Q2 market share of solely 5.5%! A serious drop from final yr’s 8.8%. To not be impolite, however that could be very un-Amazon-like. What provides?

What provides is that Rocket’s gross sales power is direct to the buyer. That works very nicely throughout a refinancing growth, when house owner loyalties are up for grabs. However the residence buy mortgage determination is closely influenced by realtors, who’ve their very own lender loyalties. Rocket bizarrely refuses to interrupt out its residence buy and refinancing quantity in print, nevertheless it clearly has a lot higher refi than residence buy share.

With refinancing largely lifeless for at the very least a couple of years, Rocket’s market share has taken successful that may at finest take years and a number of advertising {dollars} to get well.

My Rocket earnings estimates

I anticipate Rocket to earn round $0.50 per share this yr and subsequent yr, and $1.00 in 2024. Right here is my earnings mannequin:

Supply for historic information: Rocket monetary reviews

My key assumptions are:

• Nationwide mortgage originations are the Mortgage Bankers Affiliation’s forecasts.
• Rocket’s share bottoms this quarter at 5.5% and progressively rises as Rocket spends cash to develop its residence buy market share.
• The acquire on sale of mortgage originations additionally bottoms this quarter and rises to its 2019 stage by 2024 after I assume the trade’s extra capability is absolutely squeezed out.
• MSR worth adjustments characterize adjustments within the anticipated lifetime of the loans Rocket providers (collects funds). The chances are that Rocket will write up the worth of its MSRs if rates of interest keep flat or rise, however as a result of this can be a non-cash merchandise, I don’t embrace them in working revenue.
• Working bills have down and up drivers. Rocket’s down driver is lowering capability due to the mortgage origination decline. The up drivers are (a) efforts to realize mortgage buy share, and (b) Rocket’s fintech diversification efforts. My expense estimates hopefully fairly replicate these cross-currents.

Wrapping up – Nonetheless too early to purchase

Rocket goes to have a difficult 12-18 months forward of it. Earnings must be close to zero for 3 or extra quarters, excluding MSR marks. There is no such thing as a motive to rush into the inventory. At $7, or 20% beneath the present worth, you must have a stable long-term funding.