Investors looking for an alternative play in the financial services sector that's also cheaper than the big banks are putting their money into mortgage lender Equitable Group Inc., especially now that it's dropped in price.
Shares of the Toronto-based company, which operates across Canada as Equitable Bank, are off their record high reached late last year, alongside other financial services stocks that have been hit by the weakening outlook for the Canadian economy.
Some investors see the dip in Equitable as a buying opportunity given its expanding portfolio and rising return on equity, which was about 18 per cent in the first quarter.
Equitable is also less expensive than most of the big banks and some of its alternative bank peers, trading at about eight times forward earnings.
Equitable caters to borrowers considered higher risk, such as the self-employed and new immigrants, allowing them to charge higher mortgage rates. It also offers commercial mortgages.
The bank, which also provides savings accounts and guaranteed investment certificates, has expanded its products into more traditional mortgages and broadened its network across Canada.
"It's a great business to be in," said Stephen Takacsy, chief investment officer and portfolio manager at Lester Asset Management.
His firm started buying the stock earlier this year when it dipped into the mid-$50s range, and was buying again on Monday after the stock slid on concerns about mortgage originations from a competitor, Home Capital Group Inc.
Home Capital warned late Friday that its single-family residential mortgage origination volumes fell in the second quarter after a review of its business partners, which caused it to end relationships with certain mortgage brokers. Home Capital stock fell 18.92 per cent on Monday.
National Bank Financial analyst Shuba Khan said he doesn't have any concerns about Equitable Group's originations in light of Home Capital's announcement.
"The issues that Home Capital highlighted appear to be company-specific," said Mr. Khan, who has an "outperform" (similar to "buy") and $71 target on Equitable Group.
Of the six analysts that cover the stock, three have a "buy" or equivalent rating, while three say "hold." The consensus is $72.75, which is just above its record high of $72.49 in December and about 25 per cent above where the stock is currently trading around $58.
Mr. Khan likes Equitable's growing market share and recent entry into the prime insured mortgage market.
Equitable has also been expanding geographically into markets such as Quebec and the Maritimes.
"They're growing in markets that have been underserved by alternative lenders," Mr. Khan said.
As of March 31, about 61 per cent of the company's mortgage business was in Ontario, 16 per cent in Alberta, 10 per cent in Quebec, 6 per cent in B.C. and the rest in other provinces.
GMP analyst Stephen Boland has a "buy" and raised his target to $81 from $75.50 in May, after the company said first-quarter profit and earnings per share both increased 16 per cent to a record $29.5-million and $1.81 a share, respectively.
"We believe the outlook remains positive and [Equitable's] focus on product expansion while maintaining credit quality and operational efficiency will continue to deliver strong results into 2015 and beyond," Mr. Boland said in a note.
Equitable recently increased its quarterly dividend 12 per cent to 19 cents a share.
Equitable chief executive officer Andrew Moor said the company plans to raise dividends by more than 10 per cent each year. The current yield is about 1.3 per cent.
"We're a dividend growth story," Mr. Moor said in a recent interview.
He said the company's goal is to increase earnings in the future at the same rate as in the past, "which we think is entirely possible."
RBC Dominion Securities Inc. analyst Geoffrey Kwan has a $69 target and "sector perform" (similar to "hold") on the stock. He believes the discounted valuation is fair in part because of its smaller market capitalization for a bank, around $930-million, and lower share liquidity. The company has about 15.5 million shares outstanding and a 68-per-cent float.
"The recent entry into the residential prime insured market should be positive for valuation and we believe investors with a longer-term investment horizon may find the current share price attractive given expected earnings-per-share growth, but in our view there are other stocks within our coverage universe that offer greater valuation upside in the near term," Mr. Kwan said in a note.