Bank Of Canada Cuts And CMHC Support Will Sustain Demand

Key Takeaways

• Revenue growth is bolstered by increased mortgage originations from government incentives and rate cuts, particularly in high-cost urban areas.
  
• Technology upgrades entail initial costs but promise long-term efficiency and margin improvements.
  
• A decrease in net interest margins and increased costs linked to technology and staffing may reduce profitability, compounded by economic concerns and market conditions.

Catalysts

First National Financial Corporation, together with its subsidiaries, originates, underwrites, and services residential and commercial mortgages in Canada.

• Expected growth in single-family mortgage originations is driven by improved mortgage commitment levels, without the need to adjust pricing or credit quality, suggesting potential for increased future revenue.
  
• Recent government incentives and a series of Bank of Canada rate cuts are contributing to higher originations, particularly larger insured mortgages in high-cost cities, which can positively impact revenue growth and net margins.
  
• The anticipated normalization of net interest margins (NIM) following temporary compression due to higher short-term funding costs presents an opportunity for improved earnings as funding costs align with rate cuts.
  
• Planned technology upgrades involve significant upfront IT expenses, but these investments are expected to deliver efficiency advantages and potentially enhance net margins in future years.
  
• Continued strong demand in the multi-unit residential sector, supported by CMHC's affordable loan programs and natural pipeline from existing construction loans, indicates stable to growing revenue and margins in the commercial mortgage segment.

First National Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming First National Financial's revenue will grow by 18.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 29.2% today to 25.9% in 3 years time.
• Analysts expect earnings to reach CA$294.7 million (and earnings per share of CA$4.83) by about May 2028, up from CA$199.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.6x on those 2028 earnings, down from 12.2x today. This future PE is lower than the current PE for the CA Diversified Financial industry at 10.8x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.75%, as per the Simply Wall St company report.

First National Financial Future Earnings Per Share Growth

Risks

• A significant drop in net interest margin (NIM) due to amortization of high-margin pandemic era mortgages and temporarily high funding costs could reduce profitability. This is a key concern for net margins.
  
• Lower revenues from core operations, such as mortgage servicing and third-party underwriting, amidst declining interest rates and tighter placement margins, may inhibit earnings growth.
  
• Elevated costs, particularly from a 7% increase in headcount and significant spending on technology upgrades, could continue to pressure operating expenses and reduce net margins.
  
• The possibility of reduced commercial mortgage originations due to CMHC's more cautious stance and evolving market conditions could impact revenue and earnings.
  
• Risks associated with economic factors such as potential recession, cross-border tariffs, and job losses may adversely affect housing market activity and First National's revenue streams.

Valuation

• The analysts have a consensus price target of CA$43.6 for First National Financial based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CA$1.1 billion, earnings will come to CA$294.7 million, and it would be trading on a PE ratio of 10.6x, assuming you use a discount rate of 6.7%.
  
• Given the current share price of CA$40.6, the analyst price target of CA$43.6 is 6.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.