Dan Loeb's pitch for Rocket and my 'first look' analysis
On Monday, I shared highlights from 40 second-quarter 13Fs.
But I didn't mention the moves from Dan Loeb of hedge fund Third Point. That's because I wanted to dedicate a separate e-mail series to three of his latest stock picks...
In his second-quarter letter to investors, he discussed his fund's new positions in mortgage originator and servicer Rocket (RKT), convenience-store operator Casey's General Stores (CASY), and live-event operator Informa (INF.L).
I've known Dan for more than 20 years, and I think he's one of the smartest investors out there – with a track record to back it up. So today, let's take a look at the first stock idea on his list...
Rocket is the parent company of Rocket Mortgage, which used to be called Quicken Loans.
And as Dan notes in his letter, the company is gaining persistent market share of the fragmented mortgage-origination industry. This is mainly driven by its recent acquisition of Mr. Cooper, the leading mortgage servicer:
We view the combination of Rocket and Mr. Cooper as a transformative, synergy-rich merger between two technology leaders in the otherwise parochial and cost inflationary mortgage industry. Combining the largest refi originator with the largest servicer will, we believe, enable pro forma Rocket to turn ecosystem unit economics on its head.
Dan also notes how the company's use of AI should help drive further market-share gains:
Rocket has begun to realize the benefits of automating workflows – from income verification to document submission, to credit score verification – in ways that set it apart from others in the industry.
Turning to the stock chart, RKT has had a wild ride since going public in August 2020...
As you can see, it initially soared above $30 per share. In the next two years, it fell below $7. Then it spiked to around $20 last August, before dropping to around $10 this January. Now it's back up again, closing yesterday at $18.44.
We need to figure out why the stock has been on such a roller-coaster. So let's take a look at Rocket's financials through my "first look" lens...
As always, I start by looking at revenue and net income (on Capital IQ, the data only goes back to 2017):
In 2020, revenue tripled and net income went up more than 10 times.
At the time, homeowners nationwide took advantage of low interest rates and rushed to refinance their mortgages. (The average 30-year fixed mortgage rate fell below 3% for the first time in July 2020. And in January 2021, it reached a record low of 2.65%.)
This trend continued through 2021, though not quite to the same extent, before returning to prior levels. We can see the trend more clearly quarter to quarter:
Turning to the cash-flow statement, annual free cash flow ("FCF") is all over the map:
In 2021 and 2022, FCF tracked net income with a one-year lag. Otherwise, it has been consistently negative – not a good sign. But the business has almost no capital expenditures ("capex"), which I like to see.
In the quarterly data, we can see that FCF is very seasonal. And there has been a downward trend over the past three years:
Turning to the balance sheet, Rocket's net debt initially appears problematic. It was $14.9 billion as of the end of the second quarter:
However, this debt reflects mortgages the company hasn't yet sold to government-sponsored entities like Fannie Mae and Freddie Mac.
Rocket only originates and services loans, but it may hold them for a few days before they're sold. This is reflected on the balance sheet as loans held for sale (an asset) and debt to finance them (an offsetting liability). So I'm not worried about Rocket's debt.
Lastly, let's look at Rocket's capital allocation since it went public:
In 2021, Rocket used its sudden, massive FCF to acquire Truebill (now known as Rocket Money) for $1.3 billion. It also paid a special dividend totaling $1.8 billion.
For the next few years, it didn't do much other than buy back a tiny bit of stock.
But in March, it announced two major acquisitions: Mr. Cooper for $9.4 billion, as Dan discussed, and real estate-listings portal Redfin for $1.8 billion.
So, what is Rocket's current valuation?
At yesterday's close price of $18.44, its market cap is $38.8 billion. (Note that the share count will go up significantly after the two acquisitions close.)
Analysts project the company will earn $0.21 per share this year and $0.65 per share next year. That gives the stock a price-to-earnings ratio of 87.8 times this year's estimates and 28.4 times next year's.
Those are rich multiples, but I don't think Dan is crazy to pay them. Rocket is a market-leading company whose business could take off if interest rates drop and the mortgage market recovers.
However, this stock isn't for me...
It's a highly cyclical business, and I don't feel I have any special insight into what its future holds. If anything, I'd want to be buying at multiyear lows, not highs.
Over the next few days, I'll be taking a look at the other two stocks from Dan's letter: Casey's General Stores and Informa. So stay tuned...
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.