In a note to clients Compass Point Research & Trading says it remains neutral on Nationstar Mortgage Holdings(NSM), but it is raising its price target to $35, up from $30.
Compass Point says that Nationstar brought down their EPS guidance for fiscal 2014 due to the expectation for a smaller servicing portfolio and a 'softer' origination market. This was largely in line with analyst expectations given origination headwinds and the slowdown in bulk servicing transactions for the largest special servicers, the firm says.
“On a positive note, the company did make a small amount of progress towards its guidance for 11 bps of pretax margin in the servicing segment over the course of FY14 by reporting 7.0 bps of servicing pretax margin. NSM will need to make significant leaps in profitability (average 12.3 bps over the remaining 3 quarters), while growing the servicing portfolio over the next several quarters to hit their guidance for the year,” the client note reports. “We do expect NSM to make progress towards this goal and probably reach 11+ bps of pretax margins by the end of the year, but not for the entire year, given it will take time to work through all of their various initiatives.
“That said, we expect the market to begin discounting FY15 as we enter the back half of FY14 where we expect servicing pretax margins closer to 12 bps. Hence, we are increasing our price target to $35 as we look toward a more normalized earnings run rate in FY15,” Compass Point said. “We are also adjusting our FY14E EPS to $3.18 from $3.64 and FY15E EPS to $4.25 from $4.50. If the company shows material progress towards its guidance, we would be more constructive on the stock.”
This raises the question: Can Nationstar achieve its servicing guideline?
Nationstar reported servicing pretax operating margin of 7.0 bps in the first quarter of 2014, but will need to report 12.3 bps of servicing margin (on average over the next 3 quarters) in order to hit the average 11 bps guidance in 2014, Compass Point analysts Kevin Barker and Steven Seperson say.
“Over the next year, SolutionStar will be playing a much bigger part in driving servicing earnings. In 1Q14, SolutionStar reported pre-tax income of $35M on revenue of $79M (45% margin), while the company guided to pre-tax income of $215M in FY14 on revenue of $400M (54% margin),” the analysts said. “Considering SolutionStar is just ramping up with its REO sales on the BAC portfolio, we would expect material progress over the next quarter or two. The company is guiding for 20k REO sales in FY14 and 165k over the next 4-5 years.”
Analysts say that in addition to the tailwind from higher REO sales, the servicing segment could benefit from lower delinquency rates, workforce management, and a decline in interest expense from lower advance balances.
“We currently estimate SolutionStar revenue grows 35% through the year on the back of a 60% increase in REO sales,” they said.
On the downside, the analysts have a high level of confidence Nationstar can drive down DQ rates and increase the efficiency of its workforce, which should add an incremental 2.0-2.5 bps of to pretax servicing margins.
“In addition, given the pool of 165,000 of REO the company needs to sell, a run rate of 20,000 sales per year should be achievable. If we assume fees from REO sales decline by 200 bps per loan, this would imply SolutionStar pretax margins should add an incremental 2.5 bps to pretax servicing margins. These initiatives would bring the run rate pretax margin closer to 11.0-11.5 bps, implying $3.00-3.20/share of servicing earnings. At an 8.0x EPS multiple this would conservatively assume a valuation of $25/share without giving credit for the origination segment,” the two said.