Rocket Companies
Moat: 2/5
Understandability: 3/5
Balance Sheet Health: 3/5
Rocket Companies is a fintech holding company that primarily operates in the mortgage and financial services sector, with its core business being mortgage origination, loan servicing, and real estate services, with a significant focus on technology-driven solutions.
Investor Relations Previous Earnings Calls
The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.
Rocket Companies, formerly known as Quicken Loans, is recognized for transforming the mortgage industry through its online platform, Rocket Mortgage.
Business Overview
Rocket Companies operates primarily through two segments:
- Direct to Consumer: This segment focuses on providing an end-to-end mortgage experience directly to consumers, leveraging digital platforms like Rocket Mortgage, Rocket Homes, and Rocket Loans. This approach emphasizes convenience and speed, aiming to capture market share through user-friendly interfaces and technology-driven processes.
- Partner Network: This segment caters to mortgage brokers, financial institutions, and other third parties through its wholesale channel. Rocket Pro TPO allows brokers to offer Rocket products to their clients. This approach allows the company to benefit from diverse distribution channels.
Revenue Distribution
Rocket’s revenue is mainly driven by mortgage originations, where it earns revenue from loan origination fees and gains from sale of loans. The company also generates income from loan servicing, where it earns fees over time as mortgages are paid. Additionally, the company generates revenue from real estate services and title & closing services.
Trends in the Industry: The mortgage industry is subject to a number of influences. These include interest rates, economic conditions, regulation, and the housing market. Rising rates, for example, will directly affect demand in the mortgage market.
Margins and Competitive Landscape
Rocket Companies operates in a highly competitive market characterized by various national mortgage lenders and also a rapidly growing number of fintech companies. The main competition comes from companies like United Wholesale Mortgage and PennyMac. The profit margins are directly tied to loan volumes and interest rates, as rising interest rates typically cause a slowdown in the market.
Moat Analysis: 2/5
Rocket Companies doesn’t possess a wide economic moat but has characteristics of narrow moat:
- Brand Recognition: Rocket Mortgage has established strong brand recognition and a reputation for tech-driven efficiency. This brand recognition and tech focused offerings can potentially create customer lock-in, at least with younger demographics. This is an advantage over other traditional mortgage companies. However, brand recognition is not sufficient alone to create wide moat.
- Proprietary Technology: Rocket’s proprietary technology and data analytics capabilities create a barrier against easy replication by traditional players, giving Rocket some competitive advantage. However, it is not unassailable as there are other fintech companies with similar technology offerings.
- Scale and Efficiency: The company’s scale in processing large volumes of loans does create some efficiencies, that results in lower costs and time associated with each loan, thus increasing its overall value and attractiveness as a lender. However, larger traditional banks and other lending companies may also be able to produce such scale advantages and efficiencies.
Overall, there are no large switching costs associated with using Rocket, therefore it is easy for borrowers to move to competitors. Also, there are no major network effects at play, for example, borrowers are not more likely to take loans with Rocket if other people are using the same platform as it doesnt add any additional value to the borrower. Because of this, a narrow moat rating is best. It has some competitive advantages, but is not a wide moat company.
Risks to Moat and Business Resilience: The primary risk to Rocket Companies’ moat stems from its vulnerability to changes in interest rates and regulation. With rising interest rates, the value of existing mortgages decreases. Higher rates also lower the market demand for mortgages and hence reduces revenue for the company. The company is also subject to new and emerging regulations that would change the nature of the market drastically and could undermine its position. Moreover, the company’s ability to acquire and retain customers will depend on its marketing effectiveness, brand image, technology capabilities, and customer service operations. Poor handling of any of this may create weakness and vulnerability.
Business Resilience
While Rocket’s technology and brand recognition provide some resilience, the highly cyclical and competitive nature of the mortgage industry presents challenges. Periods of economic downturn will affect its revenues negatively. As such, the company may not be able to maintain strong and stable returns when the industry is facing headwinds.
Financial Analysis
Recent Performance: Rocket Companies has experienced a challenging past few quarters due to a combination of rising interest rates, falling home sales, and other macro conditions impacting the housing market.
Income Statement Analysis
The financial results for the second quarter of 2023 demonstrate the issues caused by the above conditions:
- Revenue: Total revenue for Q2 2023 was $1.2 Billion, a decrease of 37% year-over-year. The decrease in revenue was a result of lower mortgage volume. Origination revenue was $503 million compared to $2.1 billion in the year before quarter. While service revenue was $1 billion compared to $1.1 billion in the same period.
- Net Loss: Rocket Companies reported a net loss for the quarter of $360 million, compared to a net income of $1.0 billion in the same quarter last year. The loss was mostly caused by impairment to their mortgage servicing rights portfolio.
While there were significant decreases, certain things were still promising:
- Profit on Sale of Loans: Gain on sale margins was 2.99% in Q2 2023, up from 2.76% in Q1 2023.
- Origination Efficiency: Their unit production costs were down to $5,226 per loan originated, from $7,800 at peak level.
- Purchase Volume: Home purchase volume was up to $22.4 billion, from $21.3 billion in Q1 2023, this shows positive growth outside refinancing.
The business has had volatile revenue, and negative profits in the past few years as can be seen in table below:
| Year | Revenue(in Billions) | Net Income(in Billions) |
|---|---|---|
| 2018 | 5.3 | 0.4 |
| 2019 | 5.1 | -0.1 |
| 2020 | 15.7 | 2.3 |
| 2021 | 13.0 | 2.1 |
| 2022 | 5.7 | -3.0 |
Balance Sheet Analysis
The balance sheet for RKT has a few factors to note:
- Cash Position: As of September 30, 2023, Rocket has a cash position of around $1.2 billion, and a mortgage portfolio held for sale of around $7.4 billion. While the mortgage portfolio provides liquidity, they are subject to market fluctuations in price and are not as stable as cash.
- Debt: The company has a substantial debt load of over 10 billion dollars, comprised of both short term and long term debt.
- Shareholder Equity: The company’s equity has taken a large hit in recent years as a result of negative earnings. While equity levels were over $10 billion at the end of 2020, it has decreased to $1.4 billion by end of 2023.
Cash Flow Analysis
- The company’s cash flow from operations have been volatile, similar to revenue and net income.
- The company uses a large amount of cash for investing activities and financing activities in debt and share buybacks.
Understandability: 3/5
While the basic model of what Rocket does is not difficult to understand, it does become complicated once you dive into specifics. Its main driver of business, mortgage origination, is easy enough to grasp. However, it also has different lines of business which are less well-known. Specifically, the intricacies of the company’s financial reporting, mortgage servicing operations, and the role of technology in creating value can be difficult for the average investor to understand.
Balance Sheet Health: 3/5
While Rocket Companies still has substantial assets and a decent cash level, a number of factors make the balance sheet a bit risky. The large mortgage portfolio held for sale, while able to be converted into cash, are still subject to market changes which reduce their value if the market deteriorates. On the other hand, the company has a significant amount of debt, and an unstable equity level. While the company’s recent efforts to reduce the cost of operations may turn things around, there is still an underlying risk in the balance sheet.
Recent Concerns and Management Perspective: The primary concerns that have been highlighted are the impact of rising interest rates on mortgage originations and the company’s ability to generate profits amid this changing market condition. In particular, the steep interest rate hikes have caused sharp decreases in its mortgage business.
- Management acknowledges these concerns and has actively emphasized cost-cutting measures, increasing efficiency in their operations, and diversification efforts into other lines of business. The company has also mentioned plans to increase its investments in developing and deploying technology.
- In the most recent earnings call, the management noted that the company is focused on a balanced approach which includes taking advantage of gains during the market upturn and focusing on cost management during downturns to remain as competitive as possible.
- In particular, management said that in the “down-side case”, which assumes a significant level of home price depreciation, they would take steps to conserve their liquidity and profitability as well as focus on generating free cash flow, which could mean slowing hiring or cutting marketing spends.
In conclusion, Rocket Companies has a narrow moat, a middling financial strength, and a business that is moderately complex. While the company has certain advantages in terms of brand recognition, technology and scale, it is still vulnerable to the volatility of the market and competition, as well as changing regulations.