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Buy Title Insurer Stocks: KBW

NEW YORK ( TheStreet) -- The nation's largest title insurers have underperformed this year, setting up an excellent long-term opportunity for investors, according to KBW analyst Bose George.

George on Sunday upgraded Fidelity National Financial (FNF - Get Report) and First American Financial (FAF - Get Report) to "outperform" ratings from "market perform," and in a note to clients wrote that KBW was "changing our valuation approach to value the companies based on longer-term earnings."

"While the sector has underperformed in 2013 given concerns about slowing refinance volume, we expect the market to start looking more to longer-term earnings as a way to value the sector," George wrote, adding "We expect earnings to trough in 2014 and grow strongly starting in 2015 driven by the ongoing recovery in the home purchase market."

The two companies control roughly two-thirds of U.S. title insurance volume.

George raised his price target for Fidelity National Financial to $31 from $27, while sticking with is $28 price target for First American Financial.

Shares of Fidelity National closed at $23.71 Friday, returning 2% this year. First American's shares closed at $20.90 Friday, down 12% this year.

Meanwhile, the Dow Jones U.S. Financials Index was up 17%.

One of the reasons for the market's negative view of the title companies has been the decline in mortgage refinance activity, which the Mortgage Bankers Association projects will accelerate sharply next year. According to the MBA's latest mortgage finance forecast, total mortgage refinance volume in the U.S. will decline from $1.247 trillion in 2012 to $973 billion in 2013 and $388 billion in 2014. The MBA expects total mortgage lending volume to decline from $1.750 trillion in 2012 to $1.592 trillion this year and $1.091 trillion in 2014.

While those figures aren't pretty, George on Sunday pointed out that "Since the MBA data does not reflect cash sales, it understates the level of purchase activity." The National Association of Realtors has estimated 30% of all home sales are cash sales.

And title companies make money from every home sale, regardless of how it is financed.

KBW expects the title companies to see a decline in transaction volume, but to a far lesser degree than the decline in refinancing volume.
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