Author Topic: HCG.to - Home Capital Group  (Read 87428 times)

KCLarkin

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HCG.to - Home Capital Group
« on: January 10, 2015, 10:46:40 AM »
I'm not going to do a full write-up on this unless it drops a bit further. I just want to move any discussion off a different thread.

Long thesis:
- Incredibly well-run Canadian bank with 20% ROE, growing 15% per year. 10x P/E.

Short thesis:
- Sub-prime lender exposed to a housing bubble that will soon collapse. (Plus Canada is in trouble due to tumbling oil prices, weak employment, weak dollar, etc).
http://www.bankofcanada.ca/wp-content/uploads/2011/06/sp150611.pdf
http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/shorting-the-housing-bubble-in-canada/
http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/canadian-housing-bubble/
http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/canada-housing-sentiment/

Disclosure:
No position. I don't trust management anymore.
« Last Edit: May 16, 2016, 01:21:07 PM by KCLarkin »


KCLarkin

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Re: HCG.to - Home Capital Group
« Reply #1 on: January 10, 2015, 10:48:42 AM »
Due North: Canada’s Marvelous Mortgage and Banking System:
http://www.aei.org/publication/due-north-canadas-marvelous-mortgage-and-banking-system/

Schwab711

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Re: HCG.to - Home Capital Group
« Reply #2 on: January 10, 2015, 01:56:16 PM »
Due North: Canada’s Marvelous Mortgage and Banking System:
http://www.aei.org/publication/due-north-canadas-marvelous-mortgage-and-banking-system/

People act as if Canada's population is more fiscally responsible and somehow better at paying their mortgage. The last 5 years they have avoided a housing downturn due to a near 100% growth in consumer debt levels. Housing prices to Income is increasing and over 5 vs. 2.2 in the US (and decreasing). Retail debt levels cannot increase any further without even more risk, Canada has to experience a serious recession or start growing at 4%+. Jobs are around 0-25k each month and decreasing. This looks like a bubble that seems likely to pop. I hate calling bubbles in anything, especially some market I've never even participated in. I did used to work as a financial analyst for one of the 4 banks and I thought this was a bubble 3 years ago when the leverage numbers were significantly lower. Something to keep in mind as their economy has significant amount of debt and is highly levered to commodity prices.

Liberty

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Re: HCG.to - Home Capital Group
« Reply #3 on: January 10, 2015, 03:55:36 PM »
I wouldn't touch anything that exposes me directly to the canadian housing market, especially not at this point (super high debt levels, houses almost costing twice what they cost in US, oil crashing, mining doing badly for years, US economy doing better which means Canada might be forced to follow US in raising rates at some point even if things are worse here, etc). I know a lot of people who like this business a lot, and I haven't done the work on it, so maybe I'm missing something, but to me it gets thrown in the "too hard" pile because of the housing bubble, which will no doubt damage all kinds of things that are close to the epicenter in all kinds of unforeseen ways.
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Potato

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Re: HCG.to - Home Capital Group
« Reply #4 on: January 11, 2015, 10:11:24 AM »
I briefly looked into them almost two years ago (coming at it from the housing bear angle). The only conclusion I could reach was that they were run by wizards.

  • They grow like stink, but spend next to nothing on marketing/attracting business. This is going up against the big banks, which are not pussy-cats in Canada.
  • They don't attract business by discounting rates/being the cheapest.
  • They are in the non-prime sector, so people may come to them by default after being rejected by the banks. However, I haven't seen a metric from them on how many applicants they reject, and haven't heard anecdotes of them rejecting people (or seen message board posts about people complaining that they don't have a notice of assessment to show this nosy mortgage dude from Home Trust...). Plus, this is in an era of notoriously loose lending by the big banks (fog a mirror, get a mortgage! You're richer than you think!). Yet, their default rates in good times are as good as prime (but got 3X worse in 2009).

They post consistently amazing results, and don't have any of the compromises I expected would come with that kind of growth. If it's all fabricated, I'm not smart enough to tell -- it doesn't look like they're just rolling the loans before they go bad. I have concerns about the housing market, and this looks like the natural short choice, but I just can't figure out what makes it tick.

benhacker

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Re: HCG.to - Home Capital Group
« Reply #5 on: January 13, 2015, 09:23:30 AM »
I shorted a small amount of this at year end.  I am a bit nervous though along the lines of Potato's thoughts.  While Ontario (HCG's main Province) doesn't have a ton of direct oil exposure, I figured a non-prime lender trading at 2.25+x TBV wouldn't see real strong stock price in the face of a continued oil slide given that it does business in what is widely considered a petro currency country.  I also believe the knock on effects of oil will affect non-oil Canada as well (although perhaps currency effects will help Ontario more for export, etc...)

That said, although I'm doing well on my short, I still kind of scratch my head about HCG's special sauce.  Other names in Canada are likely more directly exposed to oil + china weakness than HCG, without the risk of being Phil Fisher type businesses (CWB, and FN come to mind).

I'm I'm debating what to do.  We all have different styles, but to me, HCG historical financial performance isn't that meaningful to me as I can't explain it.  Their book seems appropriately stated, so I don't really get how this business makes the ROE it does without something dark lurking.  As a short I'm basically making an event bet + a bet that even if a secret badness isn't lurking, their ROE shouldn't be able to hold steady as they grow.

In all likelihood though, I'll close my short out here sometime and move on to something else... at that point HCG will promptly collapse to 1x TBV after I exit. ;-)

If someone knows why HCG can make such phenomenal returns in a commodity industry, I'd love to hear it!
Ben Hacker
Beaverton, Oregon - USA

biaggio

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Re: HCG.to - Home Capital Group
« Reply #6 on: January 13, 2015, 12:54:42 PM »
I shorted a small amount of this at year end.  I am a bit nervous though along the lines of Potato's thoughts.  While Ontario (HCG's main Province) doesn't have a ton of direct oil exposure, I figured a non-prime lender trading at 2.25+x TBV wouldn't see real strong stock price in the face of a continued oil slide given that it does business in what is widely considered a petro currency country.  I also believe the knock on effects of oil will affect non-oil Canada as well (although perhaps currency effects will help Ontario more for export, etc...)

That said, although I'm doing well on my short, I still kind of scratch my head about HCG's special sauce.  Other names in Canada are likely more directly exposed to oil + china weakness than HCG, without the risk of being Phil Fisher type businesses (CWB, and FN come to mind).

I'm I'm debating what to do.  We all have different styles, but to me, HCG historical financial performance isn't that meaningful to me as I can't explain it.  Their book seems appropriately stated, so I don't really get how this business makes the ROE it does without something dark lurking.  As a short I'm basically making an event bet + a bet that even if a secret badness isn't lurking, their ROE shouldn't be able to hold steady as they grow.

In all likelihood though, I'll close my short out here sometime and move on to something else... at that point HCG will promptly collapse to 1x TBV after I exit. ;-)

If someone knows why HCG can make such phenomenal returns in a commodity industry, I'd love to hear it!

I am no expert. Used to own it.

Your short has worked out for you so far.

I thought these guys loaned money to folks like Ericopoly. High asset, net worth, but poor income (or there is something else wrong with their application, but they have lots of collateral) so none of the usual banks will loan to them. As a result they can charge an extra 1-2% + leverage=ROE >20%.

From what I gather this is a very favourite short idea for US investors over the years but it has not worked out for them in the past. Maybe it will this time.

Its still highly regard by respected investors like Jason Doneville at Doneville Kent for the cloners out there. I was thinking of starting a position. That said, Ben I think you continue to do well in your short position.

benhacker

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Re: HCG.to - Home Capital Group
« Reply #7 on: January 13, 2015, 01:10:23 PM »
Quote
From what I gather this is a very favourite short idea for US investors over the years but it has not worked out for them in the past. Maybe it will this time.

Yes, it's kind of obvious (in a non-intelligent way).  It's one of the larger cap non-protected Canadian financial firms that comes on a screen.  It's been highlighted by Eisman who (rightly) has a good following (although his fund closed again... long OCN / short CA RE in 2013... ouch).  High multiple to book, all judgements of value based on historical financials + low TTM / forward PE.

My main reason to jump into the fray recently is just the catalyst that crude is down in CAD huge, and the knock on effects of this I believe are almost always misunderstood.  It's uncomfortable for guys like me to short on the downswing, but in this case I think there is another easy 10-20% to be made here.... and if oil snaps back to $60 tomorrow, I don't think HCG jumps too much.

Quote
Its still highly regard by respected investors like Jason Doneville at Doneville Kent for the cloners out there. I was thinking of starting a position. That said, Ben I think you continue to do well in your short position.

Yeah, I can't really provide a super intelligent summary of why these smart guys are wrong... I only have this feeling that HCG has the classic attributes** of a company that rips value investors faces off (probably rips the face off of shorts too! ;-) )... and in the last month, I recall seeing HCG pitched as a long for the first time in circles I run in... so I guess I just couldn't hold back anymore. ;-)

**
1) Finance (commodity) company with leverage
2) Lowish PE on the surface
3) History of strong financial performance
4) Winds which drove performance (Canada RE and commodity boom) and folks are already talking like it doesn't matter

These kinds of situations are odd, if HCG does another two years of >15% ROE, I'm wrong (book builds, valuation probably holds up), but if ROE goes to 12%, income growth falls to negative %, and all of a sudden investors start valuing on book, not on EPS, and the stock is down 50% in short order.  I think sheer risk aversion will actually take HCG down prior to any financial revelation of slowing / negative EPS trends.

We'll see.  Low conviction, mostly I wanted a direct hedge as I think China has fallen out of bed, and no one is really acting on the knowledge even if they believe it as well.

</macro off>
Ben Hacker
Beaverton, Oregon - USA

KCLarkin

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Re: HCG.to - Home Capital Group
« Reply #8 on: January 13, 2015, 02:03:10 PM »
all of a sudden investors start valuing on book

Have Canadian banks ever been valued based on book? Valuing banks based on book is a deep value quirk.
http://video.cnbc.com/gallery/?video=3000151816

By the way, here is the current score for Eisman's long OCN / short HCG since May 8, 2013:
-78.62% vs +44.53%


benhacker

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Re: HCG.to - Home Capital Group
« Reply #9 on: January 13, 2015, 02:10:41 PM »
Quote
Have Canadian banks ever been valued based on book? Valuing banks based on book is a deep value quirk.
http://video.cnbc.com/gallery/?video=3000151816

?

I don't know why a valuation methodology would be specific to Canada or not, but I would say valuation methods are most certainly always (almost) based on earnings / cash flows.  I guess my point being is that some business over earn in certain years (sometimes for many years) and investors forget that tangible assets (for the most part) are what generate real profits.  Sometimes a large divergence (again, for certain businesses) between market value and book is a sign that it will be profitable for new competition to enter the market, or the economic / asset characteristics of a business are temporarily and unusually good (and will decline).  Buffett is most certainly right that banks should be valued long term on their earnings... I own WFC and many financials that have at times (or now) trade(d) above book.

But regulated, large, TBTF, banks trading at large premiums to book is a separate issue from companies like HCG trading at large premiums to book.

Regardless, my comment was not about how HCG *should* be valued if earnings decline... my comment was only how I think it *will* be valued if earnings decline.  We shall see I guess.

Quote
By the way, here is the current score for Eisman's long OCN / short HCG since May 8, 2013:
-78.62% vs +44.53%

Yes, not a wonderful call. 
« Last Edit: January 13, 2015, 02:12:30 PM by benhacker »
Ben Hacker
Beaverton, Oregon - USA