Regular readers will know this column has favoured housing-related stocks for the past 18 months. This view is based on interest rates remaining lower for longer to prop up a long, grinding economic recovery as the mining investment boom fades.
Genworth Mortgage Insurance Australia is one of the more interesting ways to play the housing trend. As Australia’s largest mortgage insurance provider, Genworth should benefit from continued strength in property demand and new housing construction in the next three years.
Granted, Genworth would be a terrible stock to own if there was a housing meltdown and more people started to default on their loans. It is not a stock for long-term buy-and-hold investors or one to hold at the tail-end of a residential housing boom.
To recap, Genworth listed on ASX in May 2014 after a much-anticipated Initial Public Offering. It raised $583 million, becoming the financial year’s seventh-largest float by capital raised. Genworth’s $2.65 issued shares opened at $2.91 on debut, and have edged higher to $3.06.
I rate Genworth for a few reasons. First, the housing-market outlook looks positive in the next few years. In spite of never-ending debate about a supposed house-price “bubble” in Australia, the reality is housing has proven surprisingly resilient over the past decade.
With record low interest rates and little pressure to increase them, in my opinion, housing demand should remain firm. Higher property prices should also lift demand for mortgage lenders insurance, which is needed when the amount borrowed exceeds certain limits, such as 80 per cent of the home’s value. All bets would be off if unemployment spiked and housing prices sank. But that scenario seems less likely over three years.
The second reason is Genworth’s market position. It has an estimated 45 per cent share of New Insurance Written in lenders mortgage insurance, and only a few large competitors. Barriers to entry are high, with Genworth relying heavily on contractual agreements with three of the big-four banks. These long-term relationships are hard for new entrants to build.
The third reason is pricing power. Genworth’s dominant position and housing-market strength should help it further increase premium rates and tighten underwriting standards with customers. It should have steady growth in net earned premiums in the medium term.
If that happens, the company should add a few points to its Return on Equity (ROE) over the next three years from about 10 per cent per cent in FY13. Rising ROE is always a good sign as it usually leads to a higher intrinsic value for the company and ultimately a higher share price.
Valuation is another factor. Genworth came to market at a price-to-book value of 0.8 times, and currently trades around 0.9 times book value. There is scope for it to trade in line with book value as its share price is re-rated, although several brokers have the company trading between 0.8-0.9 times in coming years.
Another factor is dividend yield. Genworth is expected to yield about 8 per cent, fully franked, in 2014-15. And there is scope for higher dividends in the next three years if the housing market plays out as I expect, with modest price gains and no severe correction. Capital returns from Genworth are another possibility in coming years, depending on its balance-sheet strength and regulatory rules.
The company’s expected yield is attractive in an absolute and relative sense. The big-four banks, for example, which originate most housing loans, are yielding around 5 per cent. And they look fully valued, if not a touch expensive, after stellar share-price gains in the past few years. As an aside, offshore banks such as Wells Fargo in the US offer strong exposure to that country’s strengthening housing cycle and are cheaper than our big banks.
Macquarie Equities Research has a 12-month share-price target for Genworth of $3.43. With an expected 8 per cent yield, it potentially offers an almost 20 per cent total shareholder return over 12 months, on Macquarie numbers.
Macquarie wrote of Genworth in June: “The micro reforms undertaken over the past six years in response to the (2008) Global Financial Crisis have the potential to deliver several years of earnings-per-share growth, capital returns and an improving ROE, presenting an attractive investment opportunity.”
As a mid-cap stock with exposure to the cyclical housing market, Genworth has higher risk than the big insurers and banks. But less risk, in my opinion, than most housing-related stocks and a more attractive, sustainable yield over the next three years.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at June 25, 2014.
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