Rocket Companies (NYSE:RKT) reported great earnings for first-quarter 2021 on May 5, but the market doesn’t care about historical numbers. It looks to the future. And rates are rising, Rocket mortgage margins are compressing. As a result, its earnings outlook is cloudier. RKT stock is going to rise in this kind of environment.
Indeed, since my article on April 22, when RKT stock was at $21.87, it has fallen 22.5% to $16.94 as of May 21. I pointed out that the mortgage lender’s “gain on sale” (GOS) portion of its revenue was likely going to fall as interest rates rise.
The reason is very simple. People do not refinance their mortgages and houses do not sell as well when rates rise. Everyone always wants a bargain and they would rather wait until rates fall. Moreover, now that Covid vaccines are taking effect, people are moving, getting out of the house and remodeling activity has dropped.
On top of these major trends, the company guided for lower margins and activity for Q2. For example, Rocket indicated that its GOS margins would dip to 2.65% to 2.95% down from 3.74% in Q1. This was also significantly lower than the 2020 average GOS margins of 4.46%, as I pointed out in my last article.
That is not good. It implies that the volume of mortgages produced has to rise to make up for the lower margins. The problem is the company said that its volume production would fall to $82.5 billion to $87.5 billion. This a drop of 15.5% to 20.3% lower than the $103.525 billion of completed loan volume during Q1.
Compressed margins, lower volume, higher rates. These lead to lower revenue and much lower profits. That means that RKT stock is going to keep falling. For example, analysts via Seeking Alpha now expect revenue in 2021 to fall 19.7% to $12.63 billion from $15.735 billion in 2020.
And don’t even talk about 2022. They expect 2022 revenue to fall to $10.41 billion. So, in the space of 2 years from 2020, revenue will be down by $5 billion or 33.8%. That mostly depends on how far interest rates rise.
Where This Leaves RKT Stock
This is not going to lead to good things for RKT stock. Even though the stock is cheap now at 7.6 times earnings, the price-to-earnings (P/E) ratio rises to over 10 times by 2022.
In addition, the company still has a negative tangible book value per share (TBVPS) of -$28.00. Even its book value per share (without deducting intangible assets) (BVPS) is only $4.00 per share. So RKT stock, at $16.94 as of May 21, has a very high valuation at 4.2 times BVPS. This is likely to fall to two to three times over the next year.
As a result, expect to see RKT stock fall to $10 to $12 per share. This implies a potential drop in the stock from $16.94 to $10 to $12, or 29.1% to 41% further.
I am predicting a further drop of about 35% in RKT stock to $11.00. But a good deal of this depends, as does Rocket Companies’ own forecast, on the extent to which interest rates rise and/or demand for mortgages dips.
What Analysts Think
Analysts don’t see it this way. They are all enthusiastically positive that RKT stock will rise significantly from here. For example, TipRanks reports that 14 analysts have an average target price of $21.92, or 29% higher than today. The same is true at Marketbeat, with an average target price is reported at $24.21, or 43% higher, and Seeking Alpha at $21.31.
But don’t let that bother you. The company’s own projections show much lower mortgage activity and compressed margins. Maybe analysts think that the stock already reflects this. Maybe. But I think that there is a good downside left. Markets often overdo things, including on the downside.
Most patient value investors will wait for RKT stock to become a bargain, especially in terms of its price-to-book value per share. It is still too high at the present time in that regard.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.