NEW YORK (
) -- 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
First American Financial
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.
"We expect earnings to trough in 2014 and grow strongly starting in 2015 driven by the ongoing recovery in the home purchase market," George wrote.
The analyst raised left his 2013 earnings estimate for Fidelity National unchanged at $1.95 a share, but raised his 2014 EPS estimate to $1.85 from $1.66, reflecting the company's pending acquisition of
Lender Processing Services
, which it held previously. George's earnings estimates for Fidelity National include "roughly 35 cents of accretion" to annual earnings from the LPS acquisition.
KBW expects total U.S. mortgage origination volume to begin growing again in 2015.
Fidelity National's shares at Friday's close traded for 12.3 times the consensus 2013 earnings estimate of $1.93 a share, among analysts polled by
First American's shares traded for 11.6 times the consensus 2014 EPS estimate of $1.80.
Summing up his recommendations, George wrote "While our estimates suggest that P/Es are high relative to expected earnings in 2014, we believe that within our 12-month horizon for our target price, the market will start valuing the shares based on EPS estimates for 2015 and beyond, and the title insurers look attractive based on our longer-term estimates."
Shares of Fidelity National were up over 3% in early trading Tuesday, to $24.48, while First American was up over 2% to $21.41.
-- Written by Philip van Doorn in Jupiter, Fla.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.