Throughout the last year after its initial public offering, Rocket Companies (NYSE:RKT) stock trended in the $20 – $21.50 range. RKT stock peaking on March 2 is an exception. Shares reached $41.10, albeit for less than a day, after the company issued a special dividend.
The announcement squeezed short sellers, which, unfortunately, did not last. Bears prevailed when the company posted Q1 results. What happened?
RKT Stock Sinks After Q1 Results
Rocket announced revenue growing by over two-fold to $4.6 billion. Revenue (adjusted) rose by 91% from a year ago to $4 billion. Net income grew by an astonishing multiple of 28. Rocket’s chief executive officer, Jay Farner, said “this was the sixth consecutive quarter where our team was able to double the company’s home loan volume year-over-year.”
Investors are spooked about adjusted revenue flipping sequentially from $4.78 billion in Q4. The weakness should shock shareholders while rewarding bears. The real estate market is at the most overpriced levels of all time. Unfortunately, overpriced homes slow down the rate of new mortgages. Home inventories fall and new home prices rise because of higher material costs.
Soaring lumber prices decreased affordability. Mortgage lenders like Rocket now must brace for lower demand. The competition will heat up faster than expected. Rocket, who thought its software would give it an edge on margins over Wells Fargo (NYSE:WFC), will face lower profitability.
Rocket forecast loan volume of up to $87.5 billion. Gain on sale margins will be in the range of just $2.65% to 2.95%. In Q1/2021, funded loan gains on sale margin was 5.36%, up from 4.69% in the previous year.
The Rocket Pro platform will support the partner network segment. Clients get a superior experience. Yet a good interface will not matter when margins are under pressure. Customers may stay with their bank and demand a bundled package and get better rates.
Rocket’s gain of sales of loans at $3.55 billion accounted for most of the revenues. As the business gets decimated, investors now look at Rocket for what it is.
It is not a software stock.
Rocket is a mortgage originator that happens to have a slick app. Its large marketing budget also helped drive sales. Marketing and advertising expenses topped $320.8 million in Q1, up from $217.99 million last year. That expense will shrink as revenue falls at a faster rate.
Ten-year treasury rates rose in the quarter. This pressured stock valuations. Though Rocket shares are cheap, markets will sell down expensive technology stocks Investors will also sell value stocks like Rocket because its business is shrinking.
The higher rates will pressure Rocket’s loans. Still, Farner said on the conference call that 50% of its originations are not interest-rate sensitive. He said that the acceleration in rate hikes led the company to adjust its direct-to-consumer sales expectations. Investors buying Rocket stock today are betting that rates will not rise further.
That macro bet may prove costly. Short float is close to 10%. And as rate hike risks mount, bears may continue betting against Rocket to hedge against the falling market.
Rocket did not lose analyst support. In the last two weeks, Wall Street reiterated mostly “hold” ratings. Tipranks reported an average price target of almost $22. This would imply that the stock will reward shareholders who do not sell. Simplywall.St has an $85 fair value. That will likely get re-forecasted to the downside as the site lowers cash flow expectations.
Astute investors who understand the negative impact of higher interest rates should avoid Rocket stock for now. Bank stocks, which are at all-time highs in some cases, have better prospects. The interest rate spread widens as rates rise, lifting bank profits. Investors should reduce or eliminate their exposure in Rocket stock now.
Housing prices are too high. Raw material costs are rising at accelerating rates. The Federal Reserve will need to cool the sector by hiking rates. That would send Rocket to new yearly lows in the months ahead.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.