On Friday, I decided to purchase shares in Home Capital Group, a company I have been following for a number of years. I have been waiting for an opportunity to invest and that time arrived last week, thanks to Steve Eisman, a US Hedge Fund Manager.
Mr. Eisman suggested last week, in a very public forum, that investors bet against Canadian housing, and singled out Home Capital Group. Copycat investors, primarily in the US, have now shorted 10% of the stock. US investors are listening because Mr. Eisman successfully shorted US housing stocks in 2008 before the crash.
The effect can already be seen in the stock. It is down from a 52 week high of $61.50 to $50.79. In the last week, 2.65 million shares traded, 900% more volume than normal.
Reasons to Short Canadian Housing
According to Eisman, there are a few reasons behind his thesis:
- Housing prices have doubled in Canada in 10 years
- The surge in prices has stopped in the last year
- CMHC’s balance sheet of insured mortgages is too large
Therefore, the theory goes, Home Capital Group, which specializes in providing mortgage lending to individuals who do not qualify for normal big bank mortgages, is particularly vulnerable.
Reasons Why I Think He’s Wrong
In my opinion, I think he’s wrong both on the macro front and for Home Capital Group in particular. On the economic side:
- There is no recession in Canada or the US. Without a recession, the housing market will continue as is (perhaps at a stagnant level). In fact, the US economy grew 2.5% in real terms last quarter. This is positive for the Canadian economy.
- Money is cheap; 5 year mortgages are easily available at 3% and 10 year mortgages at 3.6%. There is no end in sight for cheap mortgage money, certainly not within the next few years
- While housing sales have slowed, this is due to changes in qualification rules introduced by the Federal Government. Money remains cheap, and there is a “new normal” for real estate sales which is about 15% lower due to less people qualifying for mortgages. Due to cheap money, prices have been stable or growing across Canada although specific markets are lower in some cases (like Vancouver).
For Home Capital in particular:
- Although many of Home Capital’s customers do not have credit history, they have cash and assets. They are often wealthy self-employed or immigrants who put down large cash deposits, on average 33% of the house value
- Home Capital’s Tier 1 capital ratio is 16%, double that of most Canadian banks
- Home Capital is trading at a P/E of 7.0 based on last quarter’s adjusted earnings, with revenues and earnings both up more than 10%
- Home Capital has a normal course issuer bid outstanding and can now purchase shares back at a very attractive discount
- With a 15% dividend payout ratio, Home Capital can easily outpace dividend increases at all major Canadian financial institutions. I would expect an increase next quarter or the quarter after (they average one increase every 3 quarters)
The CEO of Home Capital also agrees. You can watch a 6 minute interview with him on BNN at this link (BNN does force you to watch a 30 second advertisement)
What could actually cause a collapse in real estate?
- A major recession, larger than in 2008
- A major collapse in commodity prices. Think oil below $50, gold below $1000 and other commodities at rock bottom, multi-decade lows
While this is not out of the question, I would also point out Home Capital Group has survived multiple recessions including the 2008 financial crisis quite well. The true risk is an economic recession and millions of Canadians out of work, not housing prices in particular.
The earning yield of Home Capital Group is now 14%. If they can maintain 10% revenue and earnings growth, which they are projecting, returns could be up to 24% per year for shareholders. Of course, returns are never that straightforward. More than likely, the stock will continue to be under pressure from short sellers until they get tired or bored in the next 6 to 12 months. Likely, there will be a 50%+ jump very quickly rather than a consistent 20-30% per year. It is hard to say when this will happen, but my prediction is within 18 months. Meanwhile, I am considering adding another 25% to my position now that it is closing in on $50.
If you have any questions, feel free to comment or send an email to firstname.lastname@example.org.