Last March, I argued that Rocket Mortgage — a Detroit-based originator and seller of home loans — was under-valued.
Since then, the stock has lost 67% of its value. On March 2, when I wrote that 39.7% of its shares were sold short, Rocket stock spiked to $43. By January 7, its shares had dropped to about $14.20.
I do not know why the stock jolted up last March — but it could have been a short squeeze. I think that many who had bet against the stock have since taken their profits. The most recent report — on December 15 — notes that short-interest was 10.3% of its float — up 7.1% from the month before, according to the Wall Street Journal.
Is the stock even more under-valued now or should you bet it will drop? I would avoid the stock at current levels.
Last March, I cited its expectations-beating growth, special dividend, and below-target stock price as reasons the stock would rise.
I also singled out the risk of rising mortgage rates — which have risen from 2.65% (30 year fixed rate) in January 2021 to 3.22% this month, according to CNN — as a possible damper on its stock.
With mortgage rates expected to go higher, the best hope for Rocket bulls is that it can grow much faster than investors expect. But those higher mortgage rates will make that very difficult.
(I have no financial interest in the securities mentioned).
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Rocket’s Disappointing Third Quarter Report
Rocket — a provider of personal finance and consumer technology brands including Rocket Mortgage, Rocket Homes, Rocket Loans, Rocket Auto, Rock Central, Amrock, Core Digital Media, Rock Connections, Lendesk and Edison Financial — has grown into the U.S. mortgage market leader, according to the Wall Street Journal.
During the pandemic, it grew very quickly. As the Journal reported, Rocket “doubled its mortgage originations in 2020 and grew them by another third through last fall. It is now the biggest mortgage lender in the country, making nearly as many home loans as Wells Fargo & Co.
Sadly for investors, Rocket’s revenues and profits fell substantially in the third quarter of 2021. According to Inman, its revenue fell 32% to $3.11 billion while net income declined 53% to $1.39 billion.
The problem facing Rocket is its dependence on its more profitable refinancing business which suffered as higher interest rates lowered demand and margins.
While Rocket Mortgage’s closed loan origination volume was down slightly to around $88 billion, less profitable purchase loans constituted a greater portion of its assets and that cost Rocket considerable profitability — with its gain on sale margin declining from 4.52% to 3.05%, noted Inman.
Rocket was excited about these results. As Jay Farner, Vice Chairman and CEO of Rocket Companies, said in a statement, “We had an excellent third quarter…Our core mortgage business exceeded the high end of guidance for closed loan volume and gain-on-sale margin, while achieving record purchase volume.”
Rocket declined to provide revenue and earnings guidance for the fourth quarter — instead it sets loan volume targets. As CFO Julie Booth told investors on November 4, “[We expect] our full year 2021 closed loan origination volume to exceed $350 billion, exceeding the previous record of $320 billion achieved in 2020 by more than 10%.”
How Rising Mortgage Rates Will Reduce Demand
When mortgage interest rates rise, demand for mortgages and mortgage refinancing goes down. That is likely to be bad for Rocket’s revenues and profits unless it can generate enough business from other services that are not so dependent on dropping mortgage rates.
Experts forecast rising rates due to higher inflation, promising economic growth and a tight labor market. Lawrence Yun, chief economist at the National Association of Realtors, expects the 30-year fixed mortgage rate to end 2022 at 3.7% while Jacob Channel, LendingTree’s
Demand for purchase mortgages and refinances is down and likely to fall. Joel Kan, MBA’s associate vice president of economic and industry forecasting, said “Refinance demand continues to dwindle, as many borrowers refinanced in 2020, and in early 2021, when mortgage rates were around 40 basis points lower,” noted CNN.
With strong tailwinds pushing — the milder Omicron variant and a resilient economy — George Ratiu, Realtor.com’s manager of economic research said, “I expect the upward momentum in Treasury rates to continue to drive mortgage rates higher.”
Demand for mortgage refinancing will plunge. As the Journal wrote, “Refinancings are expected to plummet across the industry by nearly two-thirds” in 2022.
Could Rocket Grow Faster Than Investors Expect?
Rocket is trying to diversify its sources of revenue to grow faster than these negative trends would suggest.
Rocket — which gets “almost all of its revenue from mortgages” — has been more aggressive than its peers in trying to expand beyond refinancing. Here are three examples:
- Rocket Homes, a Zillow
Z-like listings platform meant to connect it to would-be home buyers, was launched in 2018;
- Rocket Autos connects car buyers to dealers; and
- Truebill, a personal finance startup for splitting bills and canceling subscriptions, was acquired by Rocket last month, wrote the Journal.
If you are worried about Rocket’s future trajectory, you have to assess whether Dan Gilbert is the right source of vision. Gilbert, who founded the company in 1985, is now chair of Rocket — and with his wife controls 79% of the voting power of Rocket shares. He also owns the Cleveland Cavaliers.
Rocket — which bids itself as a fintech — hopes to be valued as such. The Journal noted that Rocket claimed to have 153 million visitors to its platform in 2010 — 61% more than in 2019.
Rocket aspires to turn its Rocket Homes visitors and the 2.5 million it expects to add through its Truebill purchase to become Rocket customers when they purchase a house, according to the Journal.
Analysts are not banging the drums to buy Rocket stock. According to CNN Business, 17 analysts who cover the company have a ‘hold’ rating. And “14 analysts offering 12-month price forecasts for Rocket Companies have a median target of $17.25” — about 22% above its current price.
Just because Rocket shares are 67% below their peak, it doesn’t make them cheap. With rates on the rise, I don’t see any tangible revenue growth catalysts in 2022.