Market Overview

Wedbush's Formula Of Success For PennyMac: Higher ROEs + EPS Growth


PennyMac Financial Services Inc (NYSE: PFSI), a U.S.-based residential mortgage originator/servicer, is likely to grow its earnings per share and return on equity in the coming years even if its mortgage volumes decline in 2018 and 2019, according to Wedbush.

The Analyst

Wedbush's Henry Coffey initiated coverage of PennyMac Financial Services with an Outperform rating and $30 price target.

The Thesis

The mortgage origination market is cyclical in nature so companies in the space could see "unexpected swings" in their earnings, Coffey said in a note. But in PennyMac's case, the company boasts a combination of superior return on equity and ability to generate earnings per share growth.

The company processes all of its origination through a centrally managed quality control platform while the servicing book is built around its own origination capacity and smaller flow-acquisitions. As such, the company can generate return on equity (ROE) in the low to mid-teens range. In 2016, the ROE realized on the PennyMac common equity (excluding minority interest partnership) was 13.6 percent, which was 213 basis points above than the fully taxed ROE on the company's combined equity.

Consensus estimates call for PennyMac to see a decline of mortgage volumes in 2018 and only a modest growth in 2019, the analyst said. Even assuming a 3.3 percent decline in mortgage volumes in both 2018 and 2019, the lower repayment speeds, positive growth in servicing balances, improved profitability metrics, and a lower tax rate would support positive EPS growth.

Price Action

Shares of PennyMac Financial Services hit a new all-time high of $25.20 Friday.

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