A cheap but risky bet on housing market
Mortgage insurer Genworth MI Canada Inc. has a perception problem and its bargain-basement valuation tells the tale.
The company trades at a rock bottom price-to-earnings multiple of only 5.7 times, meaning it would take a little more than five and a half years of share profit at current levels to accumulate a nest egg equal to the stock price.
The yield is eye-catching, at 6.4 per cent, a generous payout when government bonds yield next to nothing. It also trades at about 33 per cent below book value, meaning the company can be bought on the market for substantially less than its liquidation worth.
The market seldom offers up such temptations without there being the possibility of a trap somewhere around the cheese, so here is the question: Is Genworth, now trading around fresh 52-week lows, an incredible steal because the market's perceptions are wrong?
Or are its high yield, low P/E and slumping shares a warning that current profitability isn't sustainable, and investors are right to skeptical?
The knock against Genworth is that it's joined to the hip of Canada's hot housing market, and will pay if Canadians' ardour for real estate cools.
The company, the main private sector competitor to Canada Mortgage and Housing Corp., insures the mortgages of high risk borrowers who can't provide down payments of at least 20 per cent of the value of their homes.
If the Canadian housing market tanks, Genworth would be left with lower earnings as it covers loan losses from homeowners who default.
"Generally speaking, people would say that real estate prices in this country are sky high and unlike the U.S., haven't come down to earth," observes Martin Braun, president of money manager Adaly Investment Management Corp.
Mr. Braun, who doesn't own Genworth, says that if there is a "day of reckoning" for housing in Canada that leads to lower home prices "mortgage insurers are going to have to pay out those [default] claims. If it's a 10 per cent correction, no big deal, but if it's a 20 per cent correction, it could be."
The U.S. mortgage insurance industry provides a cautionary tale on what can happen if a housing market slumps.
Insurers there have been struggling with huge losses, and many companies are trading at fractions of their previous highs, including Genworth's namesake parent and 57.5 per cent majority shareholder, Genworth Financial Inc.
There are worries that Genworth Financial, which was forced in April by market conditions to halt an initial public offering of its Australian mortgage insurance subsidiary, may now try to unload more of its Canadian arm.
The Canadian company went public in 2009 when Genworth Financial, wanting to turn some of its assets into cash, sold part of its Canadian affiliate through an IPO at $19.
Mr. Braun says some investors are speculating that when or if the U.S. parent decides to sell more of its Canadian stock, "maybe that's a better entry point" for picking up the company.
The company's own take on its share price is that investors are worried about a housing market downturn.
"Why is Genworth MIC's stock trading below value? We believe the recent share performance has been most influenced by investor perception of the Canadian housing market. We are also influenced by general global economic uncertainty. In addition, numerous investors are watching the performance of our majority shareholder, who are feeling the impact of the U.S. economy and housing market," said Brian Hurley, Genworth CEO, in an e-mail response for comment.
Fallout from news of the pulled Australian IPO seems to be a big factor hitting Genworth's share price, which traded at $21.50 in Toronto just before news of the cancelled offering in April, but has been falling steadily since.
Given its inexpensive valuation, Genworth has been popping up in the holdings of some noted value investors, such as Toronto money manager Irwin Michael, portfolio manager at I.A. Michael Investment Counsel.
"As an investor, we like the company. We think it's cheap," Mr. Michael says, pointing to the yield and low P/E multiple.
Some sell side analysts are also fans. Canaccord Genuity's Evan Minsky calls Genworth a buy, with a target of $26.50. He said the company is generating more capital than it needs, and could further raise the dividend.
Mr. Michael says the Canadian housing market is fundamentally different from the U.S., with more recourse for lenders and more conservative standards. He believes worry about lower Canadian home prices in markets like Toronto and Vancouver is already priced into Genworth's stock. Still, he says it's hard to buy value stocks that look compelling, and have them become even more compelling due to a declining price.
"You have to have strong innards here. We're hanging in," he says.
Genworth MI Canada (MIC)
Close: $18.38, up 43¢