Over the past two years, the bullish thesis underpinning Home Capital Group Inc. could be summarized in two words: Warren Buffett. But since Mr. Buffett’s Berkshire Hathaway Inc. sold its 16 million shares in the Toronto-based alternative mortgage lender in mid-December, is there still a compelling reason to buy the stock?
There’s no momentum here. The shares have been stuck in a trading range that tends to top out slightly more than $17 – which is, perhaps not coincidentally, close to Mr. Buffett’s exit price of $16.50 a share.
There’s little sign of confidence in the health of the company’s assets either. On Tuesday, the shares closed at $17.15, down 31 cents, meaning that they trade at just 65 per cent of the company’s book value of $26.43 a share.
And analysts remain on the sidelines. Among the seven analysts who cover the stock, no one has a “buy” recommendation; all of them have lukewarm “hold” recommendations, suggesting they see little value here.
Yet, Home Capital, which specializes in underwriting mortgages to home buyers who can’t get mortgages from banks because of weak credit histories, has been showing improving financial strength since emerging from a liquidity crisis in 2017 that had raised questions about the company’s survival.
The shares collapsed to a low of $5.85 on May 5, 2017, down from highs above $50 a share in 2014. Depositors withdrew money from their Home Capital high-interest saving accounts on news that Ontario’s securities regulator had accused the lender of misleading investors.
To avoid insolvency, the company arranged a $2-billion credit line syndicated by the Healthcare of Ontario Pension Plan (HOOPP). In June, 2017, Berkshire Hathaway stepped in with its own line of credit and bought nearly a 20-per-cent stake in equity (at a discount). Mr. Buffett later tried to buy even more shares (also at a discount) but was rebuffed by shareholders.
With Berkshire Hathaway making a rare foray into a Canadian company amid bullish enthusiasm from Mr. Buffett, one of the world’s shrewdest investors, Home Capital shareholders now had some assurance that the company wasn’t going to disappear.
When Mr. Buffett sold his shares in December, he had made a profit of $111-million, in addition to millions of dollars in fees from the line of credit. Remaining shareholders could point to a couple of reasons to staying put: Mr. Buffett sold his shares because his stake in the company was too small to move the needle on Berkshire’s profits; and Mr. Buffett said good things about Home Capital on his way out.
Nonetheless, you have to wonder how much upside is left in the stock. Regulators are tightening lending conditions and mortgage rates have been climbing – two challenges that have been weighing on most lenders, including the big banks.
And the housing market in Toronto, where Home Capital does much of its business with recent immigrants and self-employed Canadians, is showing signs of exhaustion after years of frenetic sales activity and price increases.
Home Capital’s fourth-quarter financial results, released last week, suggested that the company has been navigating these challenges successfully, though. The company reported a profit of $35.8-million, or 46 cents a share, up from 38 cents a share in the fourth quarter of 2017.
Return-on-equity (ROE), a measure of profitability, expanded to 8.1 per cent – up from 6.8 per cent last year, though still below many other financial firms. Royal Bank of Canada’s ROE, for example, is 16.7 per cent.
So why are the shares still mired at levels well below where they were a few years ago? Jaeme Gloyn, an analyst at National Bank Financial, argued that there are still a number of unknowns.
“We continue to recommend investors await better visibility on macro-related risks as well as Home Capital’s deposit-gathering capabilities, profitability, growth and credit performance,” Mr. Gloyn said in a note.
He added that ROE is below 10 per cent at a time when the company is struggling to expand margins on its loans (owing to rising funding costs) and is embarking upon an expensive plan to revamp its technology infrastructure.
On a conference call with analysts last week, management had little to add to its performance numbers. Asked how it planned to improve its ROE to a mid-teens target, Yousry Bissada, chief executive officer, said: “That’s going to be through a combination of earnings and the strategy of returning capital to shareholders.”
The answer may have been worth something when Mr. Buffett was an investor. Without him, though, investors are going to need significantly more assurance that this company is back on its feet.