Analysts Still Love Nationstar After 17% Drop (Update 2)

Updated from 11:52 a.m. ET with market close information -- including a further decline for Nationstar's shares -- and comment from Morgan Stanley analyst Cheryl Pate.

NEW YORK ( TheStreet) -- Wall Street analysts have lowered their price targets for Nationstar Mortgage Holdings ( NSM) to reflect market reality, but several are still upbeat on the stock.

Nationstar's shares sank 17% Thursday to close at $40.75, after the company significantly lowered its 2014 earnings guidance to a range of $4.50 to $6.00 a share from its previous guidance of $6.45 to $7.50 a share. The shares dropped another 10.5% Friday to close at $36.48.

The company operates in two business segments: mortgage loan servicing and mortgage origination and sales.

Nationstar CFO David Hisley said in the company's third-quarter earnings release that the company was "not immune" to the decline in mortgage refinance applications and the decline in mortgage gain-on-sale margins, brought about by an increase in long-term interest rates.

The company reported third-quarter earnings of $81.5 million, or 91 cents a share, compared to $123.5 million, or $1.37 a share, in the second quarter and $55.1 million, or 61 cents a share, during the third quarter of 1012.

The sequential earnings decline reflected a decline in gains on mortgage loans held for sale to $206.0 million in the third quarter from $282.6 million the previous quarter.

The company also announced it would sell its "non-core wholesale and distributed retail origination channels to Stonegate Mortgage ( SGM)" this month. Stonegate said it would pay "net book value" for the unit's assets.

The year-over-year earnings improvement reflects an increase in fee income to $425.9 million in the third quarter from $145.6 million in the third quarter of 2012, as the company grew its portfolio of serviced mortgage loans to $375 billion as of Sept. 30 from $198 billion a year earlier.

Nationstar, along with other servicing specialists including Ocwen Financial Corp. ( OCN), is rapidly expanding its servicing operations as the largest U.S. mortgage lenders make massive sales of loan servicing rights, in order to move away from a part of the business that has given them so much grief in the wake of the credit crisis.

The company in January agreed to purchase mortgage servicing rights for 1.3 million loans with unpaid balances totaling $215 billion from Bank of America ( BAC). Completing the deal is complicated, because the loans in the serviced portfolio are held by several different parties. During the first quarter, servicing rights on 47% of the Bank of America-serviced portfolio was transferred to Nationstar. Those were loans held by Fannie Mae ( FNMA) and Freddie Mac ( FMCC). During the third quarter, servicing rights on $62 billion in private label loans -- that is, those that can't be sold to Fannie or Freddie -- were transferred to Nationstar.

So there's plenty of good news on the servicing front, as Nationstar continues to ride the industry trend and gobble up servicing rights. On the other hand, the company's loan origination business can't escape the negative industry trend, as the wave of mortgage loan refinancing activity in the United States subsides. Refinancing volume had spiked as a result of prolonged low-rate environment promulgated by Federal Reserve policy and because the government's Home Affordable Refinance Program. The program, known as HARP, helped qualified borrowers with loans held by Fannie and Freddie fully refinance their mortgage loans, even if the value of their homes had dropped significantly lower than the loan balances.

The Mortgage Bankers Association estimates U.S. refinance volume will decline from $1.456 trillion in 2012 to $1.083 trillion in 2013, with an even sharper decline to $463 billion in 2015. The MBA expects total one-to-four family mortgage volume to decline from $2.044 trillion in 2012 to $1.745 trillion in 2013 and $1.186 trillion in 2014.

Sticking with Nationstar

Following Thursday's drop in the share price, investors are looking at "an attractive entry point" for Nationstar, on the strength of its growing servicing business, according to Oppenheimer analyst Ben Chittenden. The analyst in a note to clients late Thursday also said that it was "not a point to sell for existing shareholders."

Chittenden stuck with his "outperform" rating for the stock, but lowered his 12-18 month price target for the shares to $50 from $62, while lowering his 2013 EPS estimate to $3.05 from $4.80, and lowering his 2014 EPS estimate to $5.50 from $7.31.

"We think this is the fundamental silver lining on an otherwise weaker quarter. Servicing will drive the vast majority of future earnings power; with profitability increasing, we view that as a positive," Chittenden wrote. He was also impressed with the growth of Nationstar's "high margin" SolultionStar subsidiary, which focuses on real estate sales and settlement services. This unit's revenue third-quarter revenue rose 34% sequentially to $51 million in the third quarter.

FBR Capital Markets analyst Paul Miller on Friday also stuck with an "outperform" rating for Nationstar, although he lowered his price target to $45 from $65, "given a 2014 EPS expectation that is nearly one-third below our prior estimate."

Miller in a client note lowered his 2014 EPS estimate for Nationstar to $5.00 from $7.50.

Miller sees plenty of opportunity for Nationstar to unlock more value for investors by "creating more tax efficient capital vehicles" or through a spinoff of Solutionstar.

Credit Suisse analyst Douglas Harter also maintained an "outperform" rating on Nationstar, while lowering his price target to $46 from $62. "Our target price represents a 9.6x multiple on 2014 EPS estimate based on sum of the parts for servicing, originations, and Solutionstar," Harter wrote in a note to clients. He emphasized that his price target really is a 12-month target, since "Nationstar will need to execute improving servicing cash flows and progress on a Solutionstar spin before we see upside to the stock."

Other Opinions

Sterne Agee analyst Henry Coffee on Friday downgraded Nationstar to a "neutral" rating from a "buy" rating, while lowering his price target to $45 from $60. Coffee estimates Nationstar will earn $5.00 a share in 2014.

"We are stepping to the sidelines to wait while the company reconfigures its operating platform to adjust to new origination targets, the closing of excess facilities, etc.," Coffee wrote.

But even after the downgrade, Coffee struck a somewhat positive tone.

"In addition to the prospects of additional new servicing, there are two other factors that could drive the shares higher: a) reduction in corporate debt. The company needs to evolve into a business that can grow revenue and EPS without increasing leverage; b) a reconfiguration of the servicing business into a structure that lowers the serving company's tax rate from 38% to an estimated 10%. The first item is critical in our view; the second worth noting," Coffee wrote.

Morgan Stanley analyst Cheryl Pate on Friday downgraded Nationstar to "equal-weight" from "overweight," with a price target of $38.

"Lower profitability in the originations business is the key driver to our reduced 2014e EPS of $4.30," Pate wrote in a note to clients. That's the lowest 2014 EPS ratio among the analysts listed here.

"We expect continued pressure on gain on sale margins, partially offset by a higher consumer mix, and lower overall volumes with the sale to Stonegate. Additionally, we think it will take some time to get to the 125bps of core pre-tax profitability in originations that management targets as the cost base is right-sized," Pate wrote.

NSM Chart NSM data by YCharts

Interested in more on Nationstar Mortgage Holdings? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

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.

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