Fears that the Canadian housing market will have a U.S.-style implosion have depressed the shares of Home Capital Group, which is slated to report first-quarter results after the markets close on Wednesday.
Home Capital is an alternative mortgage lender, advancing funds to those who typically don’t qualify for loans at a bank.
At first glance, it’s easy to see why some investors might take a cautious approach to the company. The outlook for housing is cloudy at the moment, and if Canada’s turbocharged residential property market ever does go into a serious swoon, as some pundits predict, mortgage lending is sure to take a big hit.
“The stereotype out there is that Home Capital is a pure mortgage lender and therefore stay away from that, that’s risky,” comments Jason Donville, president of Donville Kent Asset Management Inc., who thinks the pessimism is unwarranted and has taken a position in the company.
Investors who “dig below the surface realize that the risk is actually … lower than you might think,” he contends.
Some in the analyst community also believe Home Capital’s risks are overblown, providing an opportunity to pick up a quality stock, with a stellar profit record, at an inexpensive valuation.
Industrial Alliance Securities Inc. analyst Fred Westra termed Home Capital a “great business selling at a discount” in a recent note to clients. He’s pegged the stock a “strong buy” and has a target price over the next year of $75, about 35 per cent above current levels.
Mr. Westra is so bullish on the stock that he believes it should trade at a premium valuation to the banks, rather than a discount, as is now the case. Banks on average are trading at prices of about 10 times their projected share profits this year. The multiple for Home Capital is only eight.
A siren call for the bulls is that Home Capital has one of the best long-term records of growing profitability in the entire Canadian financial services industry, handily beating the banks, which usually are lauded for their business acumen.
Home Capital’s return on shareholders’ equity, or the money investors have accumulated in the company, has been at more than 20 per cent for each of the last 15 years, a period that has seen its share of business cycle ups and downs, and the more recent financial crisis.
Those bullish on the stock believe there is nothing in the cards that would cause the company’s high return on equity to collapse.
For one thing, Home Capital targets borrowers who are pretty good bets that are often overlooked by the big banks. Among its specialties are lending to the self-employed, immigrants who haven’t been in the country long enough to establish credit records, and recent university graduates with marketable degrees, such as in engineering.
Homes are also excellent collateral. Home Capital usually aims for a large down payment, which will help protect it from harm should borrowers default amid weakening housing prices. Mr. Donville says the company typically aims to have homeowners possess at least $100,000 of equity in a $300,000 house.
The equity provides a substantial cushion that would weather even a U.S.-style housing collapse, according to Mr. Donville. Historically in Canada, real estate corrections of more than 30 per cent are “virtually unprecedented,” he says.
The company’s write-offs for bad debt, at less than $1 for every $1,000 in loans, reflect its high underwriting standards.
Home Capital also has far better capital ratios, or the amount of rainy day money that could be used to withstand loan losses, than the banks. One measure of capital, known in the business as Tier One, has Home Capital at 17 per cent, far better than the 11.5 per cent at Royal Bank of Canada.
The largest institutional holder of shares is Mawer Investment Management, a Calgary-based money manager that tries to buy stocks trading at less than its estimate of their intrinsic worth. It has recently been adding to its position of about 950,000 shares, or 3 per cent of the company.
Mawer portfolio manager Martin Ferguson says investors are overly penalizing Home Capital because of worries over the housing market and its high dependence on its mortgage lending business.
But he says the company’s conservative underwriting standards and high profitability make it a buy, in his opinion. “I think that it is attractive, given the high return on equity,” he says.Report Typo/Error
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- Home Capital Group Inc$27.470.00(0.00%)
- Bank of Nova Scotia$70.090.00(0.00%)
- Toronto-Dominion Bank$57.910.00(0.00%)
- Bank of Montreal$85.610.00(0.00%)
- Canadian Imperial Bank of Commerce$100.600.00(0.00%)
- National Bank of Canada$46.200.00(0.00%)
- Royal Bank of Canada$80.750.00(0.00%)
- Updated September 27 4:00 PM EDT. Delayed by at least 15 minutes.