Rocket Companies: Back To The Ground Rocket Companies (RKT) NYSE:RKT

Rocket Companies: Back To The Ground Apr. 16, 2021 6:00 AM ETRocket Companies, Inc. (RKT)4 Comments2 Likes Summary Rocket temporarily saw its share price take off a few weeks ago driven by a momentum spike. This has quickly self-corrected itself, providing a great trading opportunity. Continued earnings pressure is seen in the near term after unsustainable earnings power in recent quarters, as support could be found here. Looking for a helping hand in the market? Members of Value In Corporate Events get exclusive ideas and guidance to navigate any climate. Learn More » De Zitting van het Symbool van het huis over een Staafgrafiek - Beurs en Het Concept van het Onroerende goederen Photo by MicroStockHub/E+ via Getty Images Rocket Companies (RKT) has been an intriguing stock to watch after it went public last summer. My last take on the name dates back from the last days of 2020 in an article called: ''After the peak''. I concluded that the investment remained an utterly difficult proposition to value at its merits as even as annualised earnings power fell from $6 to roughly $4 per share, valuation were low. This was of course driven by the abnormal year of 2020 which was a record year for the industry as normalized earnings power realistically is much lower, although the truth be said is that Rocket is a secular growth play within the industry. The mere disentangling of structural growth and cyclical nature made it a very difficult investment case, yet with shares continued to be under pressure, I did end up buying a reasonable position at $20 in January. The Thesis In December, I called Rocket nearly a binary investment case since the company went public over the past summer. The company is a pioneer in the mortgage lending industry, pioneered by veteran Dan Gilbert, with a focus on the long haul, simplicity, trust and embracing of technological solutions. This has resulted in the company having grown from holding a mere 1% market share a decade ago to 10% as of recent, as the 20% average growth rate has been bolstered by the simple fact that the industry overall has grown quite a bit as well. Automation and simplification made it a great business model for Rocket, as well as for consumers who embrace the solutions as well. On top of this secular trend was the impact of Covid-19 as record low interest rates and a race from the city to the urban areas have resulted in boom times for the mortgage origination industry, certainly as many consumers have received big assistance given the nature and speed at which the pandemic spread. Rocket went public in at $18 in August, as this was a very large offering with 1.93 billion shares outstanding, giving the company at $35 billion equity valuation. As often the case with the balance sheet of a financial institution, it is very complicated to ''read'' as the company originates loans which it sells to end investors, making that it always holds some inventory in loans, in fact ''some'' represented $21 billion back at the time of the public offering. With no real equity value on the balance sheet, the valuation was driven by earnings power and this showed a remarkable rise over the past years. The company reported sales of around $4 billion in 2017 and 2018 and a $5.9 billion adjusted revenue number in 2019. The company reported adjusted earnings of $1.3 billion, or about $0.70 per share, which worked down to a 25 times earnings multiple based on the offer price. Momentum has been crazy in 2020. First quarter sales rose to $2.1 billion on the back of $52 billion in origination volumes, with revenues of $5.3 billion in the second quarter approximating all the revenues in 2019! Adjusted profits of $2.8bilion worked down to a run rate of nearly $6 per share, for a mere 3 times multiple, as volumes and margins exploded, with longevity of those earnings being the key question. Third quarter origination volumes rose from $72 billion in the second quarter to $89 billion yet despite this increase in volumes, adjusted revenues fell a bit already to $4.7 billion, as adjusted earnings fell from $2.8 to $2.4 billion, close to $5 per share. This came as margins on the loans fell 70 basis points on a sequential basis to 4.5%, still a hefty margin. The company guided for fourth quarter volumes between $88 and $93 billion, with margins set to fall to roughly 4%, as earnings likely trend around a dollar per share for the quarter on that basis. Even if annualised earnings power had been cut to $4 per share the earnings yield of around 20% was very lucrative, although the company did not initiate a dividend yet, although it announced a billion share repurchase program. This looked compelling enough, although I am very well aware that the true normal rate of earnings power likely is much lower, as the business was doing well in 2019 yet earned just $0.70 per share. A turn in the economy or housing market (certainly given the higher interest rates in recent months) could result in big losses on the inventory of loans held on the balance sheet, on top of the reduced earnings power in such a scenario. All this and the real average earnings power over time is what drives the investment case as from this we have to disentangle the secular growth from the highly cyclical element of this industry as well. What A Quarter! The past quarter has been quite eventful for two reasons. Shares were trading dead flat in the first two months of the year but spiked higher in early March to levels in their forties as I noted that this was a momentum driven squeeze, induced by the fourth quarter results and the announcement of a $1.11 special dividend, causing me to eliminate my entire position at an average of $32, before reinitiating a position again in $22 later in March. Of course, many investors understand the battlefield between longs and short and with many shares held by insiders, the potential for a squeeze was already there, certainly given the specific conditions among certain stocks in the quarter. The fourth quarter numbers were quite solid if you ask me. Origination volumes topped the $100 billion mark, as revenues of $4.7 billion were flat on a sequential basis, yet this was better than expected. Adjusted earnings of $2.2 billion were a little softer, but the adjusted $1.14 per share earnings number was still stronger than I assumed. With the equity value having risen to $4 per share, the earnings power of the operations is still key in driving the valuation of the stock. It however is clear that continued pressure on earnings is seen with net origination volumes seen between $88 and $95 billion, as gain on sale margins are set to fall to 3.60-3.90%. So based on the fundamentals nothing much has changed over the past quarter, yet in the meantime I have made a 50% gain on my position, with shares now trading at the same levels as they did when I acquired the position. Still expecting a current $3-$4 per share earnings number in current conditions, while the balance sheet is improving and money is available to hand out to its shareholders, I continue to be upbeat, certainly as momentum and squeezes might (again) impact the stock. That said, I continue to hold discipline with the size of the position as I continue to expect quite some reversal to normal volumes and margins, which could severely limit the earnings power in the intermediate term, as well as the arrival of competitors. Comments (2.01K) | CEO is a really smart guy. At this valuation I can wait for further growth. Like bertvillamor Today, 7:55 AM Premium Comments (16) | I agree its time to sell some position before the rocket explode in the ground,