Rocket Companies' (RKT -0.89%) stock hit the market in 2020, going public as the U.S.'s largest residential home mortgage lender. Its share price subsequently rocketed as it had a record year for loan originations in 2020. But the stock price has come down sharply since then as inflation surged higher, interest rates climbed, the refinancing boom cooled, and home sales stagnated.
As the housing market appears increasingly bleak, what is the outlook for Rocket Companies as a stock?
Right now is a bad market for home buying
Since it went public in August 2020 at $18 per share, Rocket's share price has dropped down to about $7.10 -- including a 49.3% year-to-date drop. This has been a terrible market for mortgage lenders, and it may not get better any time soon, with mortgage rates expected to continue to climb.
As of early October, 30-year fixed mortgage rates hit 7%, which is more than double the rate at the start of the year. As a result, refinancings and mortgage applications have declined, but home prices remain high. In August, the median U.S. home price was still 7.7% higher than it was a year ago. With interest rates as high as they have been since 2008, people are reluctant to buy, or refinance, especially since prices are still high.
Rocket felt the pinch in the second quarter, as loan originations were down 59% year over year in the second quarter and revenue was down 47% year over year. The outlook for the third quarter is even worse, with closed loan origination volume expected to be in the $23 billion to $28 billion range, down from $34.5 billion in the second quarter.
Rocket is a market leader that has grown market share
Mortgage lending is a cyclical business, and this cycle still seems to be in full swing. Eventually, housing prices will drop, as demand shrinks. Rates will plateau, and start to come down. But the business will probably not start to turn until next year or the year after.
When it does, Rocket, as market leader in its field, should benefit. It has a few things going for it right now. It has plenty of liquidity to navigate a downturn, with almost $1 billion in cash on hand and some $7.3 billion in total liquidity. That is due to its excellent margins and efficiency. In the second quarter, its gain-on-sale margin -- the difference between the retail and wholesale cost of the mortgage -- was 2.92%, up from 2.78% a year ago, which is higher than that of most competitors.
In addition, the company has an operating margin of 38.8% and a return on equity of 39.6% -- both of which are relatively high and signal its efficiency, which stems from the fact that it is a pioneer in online mortgage lending. Pretty much the entire transaction can be done through the Rocket app, which is more convenient for the customer and cheaper for the company.
These factors also helped the company gradually gain market share over the years. At the end of 2021, it had a 9.5% market share, up from 8% the previous year, and CEO Jay Farner has a goal of 25% market share by 2030. As the largest player in its market, with strong liquidity and financials, it should be able to weather the difficult market where other smaller competitors may not be able to, creating the potential for industry consolidation.
Rocket has a low valuation
Rocket made some moves to boost its market share in the last quarter. It signed a deal with Santander Bank to originate mortgages for the bank's nearly 2 million U.S. clients. It also agreed to a partnership with Q2 Holdings, a platform that provides digital banking applications to over 500 financial institutions. Through this agreement, Rocket will enable regional banks and credit unions to offer mortgages using the Rocket platform.
Finally, it is worth noting that Rocket is extremely undervalued right now, with a price-to-earnings (P/E) ratio of about five. But does that make it a great buy? Given the state of the housing market, Rocket may not have hit bottom. I would monitor the stock for the next few quarters to see where the market is trending. Long-term, it is a winner, but right now, investors should approach Rocket with caution.
