Evkaz
Elevator Pitch
I assign a Buy investment rating to Rithm Capital (NYSE:RITM). RITM is trading at a -25% discount to its tangible book value as per S&P Capital IQ’s valuation data. In my view, Rithm Capital’s current valuations haven’t priced in its positive outlook which is supported by the multiple levers that it has at its disposal. Therefore, I have chosen to rate RITM as a Buy.
Reasonably Good Third Quarter Performance
Rithm Capital is a hybrid mortgage REIT. In its 2021 10-K filing, RITM refers to itself as “an investment manager with a vertically integrated mortgage platform” whose investments include “mortgage servicing rights, mortgage origination and servicing companies”, and “residential mortgage-backed securities.”
Notwithstanding the current headwinds in the mortgage market, Rithm Capital’s recent Q3 2022 financial performance was reasonably good.
Revenue for RITM declined by a mere -5.0% YoY from $960.4 million for the third quarter of 2021 to $912.8 million in the recent quarter. More significantly, Rithm Capital’s top line came in +5.2% higher than the Wall Street’s consensus estimate of $867.9 million. RITM’s non-GAAP earnings available for distribution per share increased by +3.2% QoQ from $0.31 in Q2 2022 to $0.32 for Q3 2022. This turned out to be +9.8% better than the sell-side analysts’ consensus forecast of $0.92.
A $968.3 million gain on fair value in investments was a key contributing factor for Rithm Capital’s third quarter earnings beat. In its Q3 2022 10-Q filing, RITM revealed that “the continued shift of our Agency RMBS portfolio toward higher coupon securities” was the main driver of its fair value gains for the recent quarter.
Another factor that drove above-expectations earnings for RITM was the increase in RITM’s interest income. Rithm Capital noted in its Q3 2022 financial results presentation that it benefited from higher interest income derived from “$12bn in servicing-related custodial deposits” in a rising rate environment.
Also, Rithm Capital’s tangible book value didn’t drop significantly as investors would have feared. According to financial data taken from S&P Capital IQ, RITM’s tangible book value per share was $11.61 as of September 30, 2022 which represented a marginal -1.5% QoQ contraction and a +4.4% YoY increase.
At its Q3 2022 results call, Rithm Capital acknowledged that the market had concerns regarding a significant decline in its book value as a result of a “huge sell-off we’ve seen in rates and the big widening we saw in credit spreads.” But RITM stressed at its most recent quarterly earnings briefing that “being extremely disciplined around hedging” has enabled it to achieve a better-than-expected book value metric for the third quarter.
In summary, RITM turned in a reasonably good performance in the recent third quarter.
Multiple Levers To Drive Stronger Growth And Better Profitability
In my opinion, Rithm Capital has three key revenue growth and cost management levers, which point to a positive outlook for RITM.
Firstly, RITM highlighted in its Q3 2022 earnings presentation that it has plans to “manage third-party capital” which will lead to a “new business line and growth” in the future.
In terms of specific assets that Rithm Capital’s new third-party managed capital business will focus on, RITM mentioned at its Q3 2022 earnings call that it will continue to “leverage our expertise” in “financial services”, while also considering other segments like “commercial real estate.” More importantly, it won’t be just incremental revenue that Rithm Capital derives from the third-party managed capital business, as recurring fees generated by this new business will reduce the volatility of RITM’s future earnings.
Secondly, there might be a greater emphasis on inorganic growth for Rithm Capital going forward.
At its third quarter investor briefing, Rithm Capital specifically highlighted that it is seeking “opportunities to acquire platforms”, particularly ones that will support the growth of “certain origination segments, including our retail divisions.” RITM disclosed at the beginning of this month that it entered into a deal to buy a “50% interest in Senlac Ridge Partners.” This is the first meaningful M&A transaction following Rithm Capital’s earlier takeover of Genesis Capital towards the end of last year, and it could possibly mark a step-up in RITM’s M&A efforts in the near term.
Thirdly, RITM also has its eyes on cost management, apart from focusing on top line expansion.
Rithm Capital stated clearly in its third quarter results presentation slides that there will be an “ongoing focus on expense reductions to right-size origination segment to current environment (weak mortgage market).” It is noteworthy that RITM revealed at its most recent quarterly earnings briefing that its number of employees has already more than halved from around 13,500 in August 2021 (after acquiring Caliber Home Loans) to roughly 6,000 in November 2022. It is apparent that headcount optimization is one of the cost levers that RITM has already utilized to some extent.
Closing Thoughts
I am of the view that Rithm Capital warrants a Buy rating, as I think that it is undervalued. Based on valuation data taken from S&P Capital IQ, the market currently values RITM at 0.75 times tangible book value, while its five-year average price-to-tangible book value (P/TBV) metric is much higher at 0.92 times.
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