Aggressive Growth And Reliance On Non-GAAP Measures Risk Overextending Resources And Margins

Key Takeaways

• Aggressive growth and high origination volumes risk operational overextension and unsustainable revenue if market conditions change.
  
• Reliance on non-GAAP financial measures and high margin strategy might overvalue assets and shrink market share, affecting earnings and revenue growth.
  
• Strong financial performance and strategic growth plans indicate potential for increased investor confidence, share price, and sustained revenue through efficient risk management and operational efficiency.

Catalysts

Operates as a real estate finance company in the United States.

• The aggressive growth strategy aiming for $5 billion in UPB by 2025 might lead to overextension of company resources and operational capacities, risking lower net margins due to increased operational and interest costs.
  
• Increased origination volumes and subsequent securitization might not be sustainable in changing market conditions, potentially affecting future revenue growth if demand for new loans decreases or if securitization market conditions worsen.
  
• The company's reliance on non-GAAP measures for financial reporting and adjustment in book value presents a risk of overvaluing assets, which could lead to adjustments impacting earnings negatively if market conditions shift.
  
• The drag on current period earnings from the issuance costs of securitizations, despite the absence of amortization expense, might signify potential volatility in net earnings, especially if the frequency and size of future securitizations increase.
  
• The strategy of maintaining high margins and credit standards in the face of potential interest rate cuts and competitive pressures could lead to a smaller market share over time, potentially impacting revenue growth and net income.

Assumptions

• Analysts are assuming Velocity Financial's revenue will grow by 11.1% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 40.0% today to 32.4% in 3 years time.
• Analysts expect earnings to reach $67.4 million (and earnings per share of $1.69) by about October 2027, up from $60.7 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 16.3x on those 2027 earnings, up from 10.6x today. This future PE is greater than the current PE for the US Diversified Financial industry at 15.9x.
• Analysts expect the number of shares outstanding to grow by 6.42% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 10.74%, as per the Simply Wall St company report.

Risks

• The increase in net revenue by 41% over the prior year's quarter coupled with a 23% increase in core earnings signals strong financial health and improved profitability, potentially raising investor confidence and supporting a higher share price.
  
• A 63% increase in loan origination volume while maintaining margins and credit standards suggests robust demand for Velocity Financial's products and efficient risk management, likely resulting in sustained or increased revenue.
  
• Successful issuance of 2 securitizations with strong demand from bond investors can enhance funding capabilities and financial flexibility, contributing positively to future earnings.
  
• The company's effective management of non-performing loans (NPLs) and net gains from real estate owned (REO) activities highlight strong asset quality and operational efficiency, potentially minimizing losses and improving net margins.
  
• Velocity Financial's strategic growth plan, aiming to reach $5 billion in UPB by 2025, if executed successfully, could lead to significant business expansion and enhanced profitability, thereby potentially increasing the company's share price.

Valuation

• The analysts have a consensus price target of $20.75 for Velocity 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 2027, revenues will be $207.9 million, earnings will come to $67.4 million, and it would be trading on a PE ratio of 16.3x, assuming you use a discount rate of 10.7%.
• Given the current share price of $19.39, the analyst's price target of $20.75 is 6.6% 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.