Rocket Companies (RKT) has gone public and although the actual company is absolutely on fire, with revenue in the second quarter twice the annual adjusted profit for the whole of 2019, the stock is certainly not on fire. After prices fell below the preliminary offering range, stocks demanded some support from underwriters on their opening day, to now trade around $ 20 per share.
Based on current annual income power, stocks earn only 3 times income, yet the problem is that I do not find this income sustainable. I find 2019 already an above-average economic year and with pro-forma adjusted earnings earning only that year at $ 0.70 per share, valuations are quite demanding as I do not feel the urge to buy this discount yet. That said, today’s income force is so spectacular that further dips may be tempting, but for now, I take a cautious stance.
Digital mortgage lending
Dan Gilbert is a true pioneer in the mortgage digitization market. He founded the company back in 1985 with the obsession to help customers achieve the American dream of financial freedom and home ownership. In the late 1990s, the company focused on digitization and over the next two decades, it grew to 20,000 deployments.
While the mortgage company may have a reputation as a fast-moving company, Rocket is in it in the long run. The company focuses heavily on clients, technology and innovation, as the ” Rocket ” brand has great recognition with customers as synonymous with simple, fast and trusted solution. The same goes for Quicken Loans, by the way.
While Rocket Mortgage recognized the potential of the Internet and digitalisation early on, its market share peaked at just 1% in 2009 and rose to more than 9% in the first quarter of this year, after growing at almost 20% per year. Since its inception, more than a trillion in loans have been provided by Rocket Mortgage. In addition to mortgages, the company has moved to adjacent markets such as real estate, auto sales and personal loans, as superior technology and customer focus should also ensure transformation of such sectors.
The main driver behind growth in recent years was the online platform Rocket Mortgage, launched in 2015, the result of years of investment in innovation and technological development. This app and solutions can make early applications of mortgage, documents for e-signing, statements and even payments, with superior customer ratings.
The company enjoyed tremendous momentum with initial volumes totaling $ 25 billion in 2009. With interest rates falling over time, and market shares slowly increasing, volumes almost hit the $ 100 billion mark in 2016 and the recent decline in rates last year pushed volumes up to $ 145 billion in 2019. The combination of lower rates and great performance, with site visits hitting 74 million last year, is what has driven this success.
The strong brand name and strong technological position make the company incredibly productive, and support its growth and margins.
Appreciation thoughts
Rocket Companies and its bankers initially aimed to sell 150 million shares in a range between $ 20 and $ 22 per share; the final demand was somewhat softer, resulting in prices being adjusted to $ 18 per share. Furthermore, the size of the offering was reduced by a third of just 100 million shares, resulting in gross revenue of $ 1.8 billion in the offering.
With 1.93 billion shares finally up for offering, this is truly an enormous IPO that gives the company a $ 35 billion valuation at the offer price and is now back at just over $ 38 billion as shares are to $ 20.
Note that the nature of the company includes a very complicated balance sheet, which amounts to $ 21 billion until the end of the first quarter. The majority consist of for sale mortgages that have recently been created, fully financed with liabilities on the other side of the balance sheet, without any significant capital appearing on the balance sheet.
The income statement is also very complicated. The company grew sales from $ 4.1 billion in 2017, to $ 4.2 billion in 2018 to $ 5.1 billion in 2019. Overall, the vast majority of sales consist of profit on sale of loans, service fee income, interest income, other income, compensation by changes in the real value of income for mortgage services.
The company has seen relatively stable margins with corporate earnings reported at $ 772 million in 2017, $ 615 million in 2018 and $ 898 million in 2019. Based on those numbers of earnings, I only pend the revenue power at just under half a dollar.
Keep in mind that the financial numbers are very complicated, as the adjusted figures for revenue for 2019 were quite impressive at $ 5.9 billion, with the company reporting adjusted net income of $ 1.3 billion, which translates into revenue of about $ 0.70 per share. Based on the offer price, this stock is valued at 25 times adjusted income reported last year.
The real momentum was seen in the first quarter. Based on adjusted accounting, the company reported revenue for the first quarter of $ 2.1 billion and a profit of $ 650 million. Once annualized, that works down to earnings of about $ 1.35 per share. The crazy momentum was driven by lower interest rates, as volumes originated in the first quarter to nearly $ 52 billion.
U.S. consumers refinanced enormously in the second quarter, as origins jumped to $ 72 billion, as these volume growth and fatter margins resulted in quarterly adjusted revenues of approximately $ 5.3 billion and adjusted revenues of approximately $ 2 , 8 billion, working at about $ 1.50 per share for the quarter alone. Annually, that works down to earnings of $ 6 per share, resulting in only a 3-fold earnings multiplier, but as it may have been obvious, this is far from sustainable.
After all, 2019 was already a pretty strong year and in that year, adjusted earnings only came in at around $ 0.70 per share, just a little over 10% over the current annual earnings power. Because I believed that 2019 was already a fairly economic year, I am very cautious about a large turnover of profits.
What now?
Other than the economic risks and the fact that interest rates may not continue forever, I am not relying on that offer. This IPO is probably a very well timed deal and the current 3 times annual adjusted income multiple is far from sustainable. Although current momentum can provide a short-term investment for investors, I feel that sustainable income is much lower than this number, and I mean far.
Furthermore, the company has real risks in case of a serious downturn, because it has quite a bit of inventory on its books, because consumers directly misuse on payments, most indirectly damaging the company in a big way. Moreover, the income base of 3-5% of the nominal mortgage value seems pretty rich if you ask me, because margins can get closer as current crazy momentum cools.
With stocks initially trading around the offer price, this suggests that underwriters should support the lower IPO price, but now they are back to $ 20. Nevertheless, I find it very easy to avoid the IPO at the moment , although continued strong operating momentum in the full term allows for a rapid strengthening of the balance sheet and enables (special) payouts to investors.
Nevertheless, pegging realistic income below a dollar per share on average and normal economic conditions make me feel no urge to buy the dip.
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Announcement: I / we have no positions in named shares, and no plans to initiate positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose supply is mentioned in this article.
