It has been a while since I covered Rocket Companies, Inc. (NYSE:RKT). In fact, it was the summer of 2021 when I concluded that even as Rocket was no longer rocking, that its performance was good enough.
This came after the mortgage company had seen a huge boom and bust cycle in the year before, as the company found itself in a bust as earnings were no longer falling. With continued market share gains seen, and lower valuation observed, I was upbeat on the shares in the long haul, provided that the mortgage market found a bottom somewhere.
Interest rates have only ticked up further, having a detrimental impact on the business with sales down substantially in 2022, even accompanied by a small loss. While modest sequential revenue growth is seen, and continuity is not a concern, the potential is there in the long run, but for that (mortgage) rates have to come down, a big if.
A Perfect Pandemic Play
Rocket went public in August 2020, amidst a boom in the U.S. housing market, as shares went public at $18 per share. The pandemic triggered a huge rally in the housing market, with both volumes and pricing jumping. While the timing of the IPO was obviously opportunistic, there was a strong secular growth story behind the business which was founded by Dan Gilbert. The company has focused on the long haul by offering simplicity, trust, and technology.
These attributes meant that Rocket has grown the business in a huge fashion. Holding a market share of just around a percent a decade before, this market share gain has approached 10% around the time of the IPO. On top of these market share gains, the market, and industry itself have seen rapid growth.
Going public at $18 per share, the company was awarded a $35 billion equity valuation for a business which took fees (spread) on mortgages which it originated (either directly or indirectly) while selling them to end investors. Pre-pandemic, in the year 2019, the company grew sales by some 50% to $6 billion on which it posted adjusted earnings of $1.3 billion.
Momentum accelerated in a huge way in 2020, with second quarter sales of $5.3 billion being almost equal to sales reported for all of 2019, and even surpassing the revenues reported in the years before (and that in just a quarter)! Moreover, second quarter earnings of $2.8 billion were unheard of, as continuation of such earnings resulted in shares trading at a mere 3 times earnings multiple.
Momentum in shares of Rocket took the shares to the $30 mark soon after the public offering, as shares ended the year around the $20 mark as shares fell to the $15 mark by year-end 2021, as interest rates started to rise. Even as peak earnings of around $11 per share around the time of the IPO had fallen to about $2 per share, multiples were still non-demanding as some real signs of stabilization were seen (with originations running in the $80s billions with margins seen near 3%).
Since 2021, shares of Rocket have seen a wild move lower, having traded in a $5-10 range for most of 2022 and year to date, amidst a relentless rise in interest rates, although shares have risen to the $10 mark again here, with investors clearly hoping that interest rates have plateaued. Moreover, the housing market is stronger than expected in this environment, although the higher interest rates depress volumes quite a bit.
In February of this year, Rocket posted its 2022 results, the year dominated by higher interest rates. Revenues were more than cut in half to $5.8 billion to basically come in on par with peak quarterly revenues in 2020. While a $780 million GAAP earnings number appeared on the bottom line, adjusted losses were reported at $137 million. This was achieved based on $133 billion in origination volumes and gain on sale margins of 2.8%, but this was the good news. Fourth quarter revenues came in at just $481 million based on $19 billion in origination volumes and margins just below 2.2%. Adjusted losses came in at $197 million, a huge loss in relation to the revenue base.
While this was quite disappointing, there was a silver lining as the company guided for first quarter adjusted sales to bounce back to $700-$850 million. In May, the company posted adjusted revenues of $882 million as adjusted losses narrowed to $111 million. This came as origination volumes fell to just $17 billion, although that margins improved to 2.4%. Despite continued higher interest rates, the company anticipated a further improvement, with second quarter adjusted revenues seen as up to $850 million to a billion.
By August, Rocket posted adjusted revenues of $1.00 billion, being at the higher end of the guidance, as adjusted losses narrowed to $33 million. This came as origination volumes improved to more than $22 billion as margins improved to nearly 2.7%. Amidst the lower activity levels, the balance sheet has shrunk to just over $20 billion, still backed up by over $8 billion in equity, equal to about $4 per share. While the sequential improvements have been nice to see, the issue is that third quarter sales are seen flattish, with adjusted revenues seen between $850 million and a billion.
Right here the earnings power of the business has been eliminated altogether as continued gains in the market share have reversed violently in 2022, with the market share down 2% points. This came as the composition of the mortgage market shifted dramatically in 2022, moving from refinance to purchase, a segment in which Rocket is traditionally underrepresented.
Holding a long-term position in the shares, which are of course underwater here, I find myself in a bit of a doubt. Given the dismal pullback in the market, it is comforting to see Rocket achieving break-even results again here.
On the other hand, mortgage rates have hit fresh highs here, as this is likely the reason why the midpoint of the third quarter guidance reveals some small sequential revenue declines. That is a bit disappointing, but on the other hand is the expectation that Rocket can deliver on $200 million in annual cost savings from the fourth quarter onwards.
Therefore, I find myself performing a balancing act. The fact that losses have been stemmed is comforting, but there is no earnings power to justify a valuation at $10 per share, but this is a highly cyclical business, of course. Hence, at this point in time, it is about the quality and safety of the investment and not earnings power, with better earnings seen at some point in time.
With no substantial green shoots in sight, I see no reason to double down on my Rocket Companies, Inc. investment here, yet am not willing to bail out, based on the expectation of long-term market share gains and sufficient average earnings power to justify appeal at prevailing levels.