As more than a year has passed since Home Capital Group Inc. (TSX: HCG) experienced substantial solvency challenges, investors are finally able to look at a one-year chart of the company without feeling alarmed. The share price movement seems “normal,” as the past year has finally started to show a normalization of day-to-day operations. When we look back to past events, however, the real catalyst came from the backstop offered by Warren Buffett in the form of a $2 billion line of credit. In spite of a high price tag for the lender, the message was sent was loud and clear: solvency will no longer be an issue for this company.
The challenge, however, is that the market did not believe the message, as shares continue to trade at very depressed levels. But over the past month or so, the trading range has moved from the $13-15 level to a level with a $15 floor price. Given that this is the first move higher in many months, the writing may finally be on the wall for a much larger jump in price.
Currently, the company has more than $1 billion in cash on the balance sheet and a market capitalization of $1.2 billion with the firepower to move shares higher. Given that solvency is no longer a concern, and the company operates in a business with consistent revenues and expenses, the re-initiation of a dividend (or undertaking of a share buyback) would be a lot easier to undertake than many would expect. The result would also be extremely favourable for investors.
And who would blame the company?
After the first quarter of 2018, book value per share remains above $23, and the expectation is that this number will increase by at least $0.43 per share, as earnings have been steadily rising for each of the past four quarters.
With what almost seems like a game of chicken between the market and the company, the question remains “who will blink first?” The good news is for those who are long the stock, as management has many tools at their disposal to offer an upward bounce. Barring another housing crisis, the company will continue to benefit from historically low unemployment, inflation, and overall improved business conditions, allowing investors to benefit from the rising of the tide over the next year.
Isn’t a decline in lending a bad thing?
In spite of a slowdown in home sales, the benefit that will be realized by the company (and investors) is the ability to deploy the net profit in areas other than new lending. As we know, new lending increases future revenues, but on the flip side, if new lending slows down, there is more money available to shrink the footprint of the company.
What would you rather own? A lemonade stand that costs $100 to open and makes $75 in net profit, or a lemonade stand that costs $1,000 to open and makes a net profit of $500?
