A 13G filed with the SEC has disclosed that Pine River Capital, a hedge fund managed by Brian Taylor, owns 3.1 million shares of PHH Corporation (NYSE:PHH). This gives Pine River 5.2% of the total shares outstanding (see Pine River’s stock picks); it may have exercised some of its convertible debt securities in building this position. PHH is a $1.3 billion market cap company with two business segments: mortgage servicing/reinsurance and vehicle leasing and management services.
We think that it’s particularly important to note what hedge funds are doing in the small-cap space, as companies with smaller market capitalizations are generally not analyzed as deeply by mutual funds and other institutional investors or covered as much in the financial media. As a result they are more likely to be mispriced. In fact, the most popular small cap stocks among hedge funds (as listed in our August 2012 newsletter) produced an excess return of 18 percentage points between September and January (read more about our hedge fund strategies).
Earlier in 2013 we had reported on Scopia Capital taking a 10% stake in PHH Corporation (read our article on PHH from January); Scopia, which is managed by Matt Sirovich and Jeremy Mindich, had owned 5.7 million shares at that time (find Scopia’s favorite stocks). Alan Fournier’s Pennant Capital Management was another major shareholder of PHH as of the end of September, with the fund owning 5.1 million shares at that time (check out more stocks Pennant owned).
PHH Corporation recently released its results for the fourth quarter of 2012 as well as the full calendar year. In the fourth quarter, net revenue was up 21% from a year earlier driven primarily by higher net income from loan servicing and a gain on the company’s own mortgage loans. While salaries and other expenses were up, PHH was able to report considerably stronger earnings than in Q4 2011. In fact, the 89 cents per share that PHH earned last quarter made it profitable for 2012 as a whole (it recorded 56 cents in EPS for the full year). While the trailing earnings multiple is still high, the sell-side seems to believe that the fourth quarter of 2012 represents a new normal for PHH and the forward P/E (based on consensus for 2013) is only 8. PHH also trades at a discount to book value with a P/B ratio of 0.8. However, many market players are less bullish as over 25% of the outstanding shares are held short.
We would compare PHH to ORIX Corporation (NYSE:IX), CIT Group Inc. (NYSE:CIT), CapitalSource, Inc. (NYSE:CSE), and Bank of America Corp (NYSE:BAC). Orix, CapitalSource, and CIT have also been reporting significant improvement on their bottom lines, while Bank of America has lagged these peers; its revenue and earnings were each down over 20% last quarter compared to the fourth quarter of 2011. Bank of America is cheap on a book basis, with a 40% discount to its book value, while CIT and CapitalSource trade at P/B ratios close to 1. Bank of America also is cheap in terms of its forward P/E of 9, but we aren’t confident enough in its business to buy the stock (other megabanks generally seem like better buys). CIT could be a good prospect: while it is still unprofitable on a trailing basis as it digs out of a poor first half of 2012, its forward earnings multiple is in line with PHH’s and revenue growth has been strong.
The hedge fund activity in PHH is interesting, and in pure value terms we like that it trades at a discount to book value. Since we’re not fully trustworthy of Wall Street analysts we would not take earnings projections at face value, but there are enough good points that we could certainly see a value investor putting PHH on a watch list to see how the next quarter turns out. Two quarters of profitability would inspire considerably more confidence than one.
Disclosure: I own no shares of any stocks mentioned in this article.
