High Mortgage Rates Challenge Growth, AI And Tech Investments Promise Future Rewards

Key Takeaways

• Rising mortgage rates and high home prices may significantly hinder Rocket Companies' revenue growth by limiting home purchases.
  
• The company's strategic investments in AI and technology could negatively impact short-term profitability due to high initial costs.
  
• Rocket Companies' strategic focus on AI, technology, and acquisitions aims to enhance efficiencies, customer service, and expand revenue streams, impacting margins and earnings.

Catalysts

A fintech holding company, provides mortgage lending, title and settlement services, and other financial technology services in the United States and Canada.

• High mortgage rates and rising home prices are expected to keep potential buyers out of the market, affecting Rocket Companies' future revenue growth opportunities as fewer individuals can afford to purchase homes.
  
• The weak home buying activity and decreased mortgage employment indicate a contracting market, which could lead to lower loan origination volumes, impacting Rocket Companies' future earnings.
  
• Rocket Companies' heavy investment in AI and technology, while potentially beneficial long-term, could strain short-term margins due to the significant upfront costs associated with research, development, and implementation, affecting net margins.
  
• The company's expansion into home equity loans, though currently successful, may face challenges if the housing market corrects or if there is a shift in consumer behavior, potentially impacting future profitability from this product line.
  
• The pursuit of market share growth in a contracting market through the acquisition of MSR portfolios could lead to increased risks and costs, which might not be fully recouped if loan prepayment speeds increase or if there's a deterioration in loan performance, impacting Rocket Companies' earnings.

Assumptions

• Analysts are assuming Rocket Companies's revenue will grow by 16.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.3% today to 1.6% in 3 years time.
• Analysts expect earnings to reach $121.5 million (and earnings per share of $0.77) by about September 2027, up from $13.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 296.1x on those 2027 earnings, up from 207.5x today. This future PE is greater than the current PE for the US Diversified Financial industry at 15.6x.
• Analysts expect the number of shares outstanding to grow by 0.62% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.91%, as per the Simply Wall St company report.

Risks

• Rocket Companies' mastery and strategic investment in AI and technology offer the potential to significantly enhance operational efficiencies, customer experience, and drive top-line growth, directly influencing net margins and earnings.
  
• The company's strong performance in servicing and origination, leveraging its vast data capabilities and technology infrastructure, including AI, positions Rocket to capitalize on future origination opportunities and profitability growth, impacting revenue and adjusted EBITDA margins.
  
• Rocket's emphasis on and success in the home equity loan segment, capitalizing on the current market demand, could lead to sustained and expanded revenue streams from new and existing clientele, affecting overall revenue growth.
  
• The ability of Rocket to attract and retain first-time homebuyers through technological innovation and superior customer service can bolster its market share in the purchase market segment, likely contributing to revenue and gross margin improvements.
  
• Rocket's strategic acquisitions aimed at expanding its servicing portfolio not only provide an immediate increase in assets but also offer long-term revenue generation opportunities through cross-selling and higher retention rates, positively affecting future income streams and operational efficiency.

Valuation

• The analysts have a consensus price target of $14.54 for Rocket Companies based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $17.5, and the most bearish reporting a price target of just $10.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.7 billion, earnings will come to $121.5 million, and it would be trading on a PE ratio of 296.1x, assuming you use a discount rate of 6.9%.
• Given the current share price of $19.31, the analyst's price target of $14.54 is 32.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.