XLF - Radian Group: Shares Modestly Undervalued Monitoring Reserves Heading Into Earnings

2023-04-04 12:52:33 ET

Summary

• The financial sector tends to feature the best returns following the final Fed rate hike.
• I see shares of Radian Group as slightly undervalued while earnings growth may be tepid.
• With a lackluster chart, selling premium in the short run could be the best play ahead of its May Q1 report.

It’s the final countdown. The last Fed rate hike could be in the cards at the May meeting. If that’s not it, then it likely will not be long before the Fed takes a permanent hold on further rate hikes if the CME Fed Watch Tool is any indicator. What’s interesting is that the financial sector tends to perform best in the six months following the last hike. Mortgage insurers could stand to benefit from easing rates and declining Treasury market volatility, too.

I see shares of Radian Group (RDN) as a soft buy today ahead of its earnings report, though its chart leaves something to be desired.

Own Financials Coming Out Of Rate Increase Cycles

According to Bank of America Global Research, Radian Group provides mortgage insurance and risk management services to lenders throughout the United States. The company operates through two segments: Mortgage Insurance and Mortgage and Real Estate Services. RDN is one of the largest private mortgage insurance companies in the country by insurance in force.

The Pennsylvania-based $3.5 billion market cap Financial Services industry company within the financial sector trades at a low 5.1 trailing 12-month GAAP price-to-earnings ratio and pays a high 4.1% dividend yield, according to The Wall Street Journal.

Back in February, the company beat earnings estimates while revenue also came in to the strong side. What I found particularly positive in the report was that investment income was strong while the financial firm released some reserves – this is a key upside catalyst to watch for in its May earnings report.

On valuation, analysts at BofA see earnings falling hard this year, reversing massive post-COVID gains in 2021 and 2022. Following 2023’s 35% EPS decline, per-share profits are seen as stabilizing in the low $3s, while the Bloomberg consensus forecast is slightly more upbeat. Dividends, meanwhile, are expected to hold at $0.80 on this high-yield name. With single-digit P/Es, it’s certainly priced for lackluster profit growth.

I notice that its forward price-to-book ratio is under 1.0 at 0.81 which is a 14% discount to its 5-year average. So, I think enough bearish sentiment has been priced into the stock, but the upside is not tremendous. If it simply returns to a 0.9x book valuation, then the stock should be in the $24 to $25 range over the coming months. I reiterate my soft buy rating.

Radian: Earnings, Valuation, Dividend Yield Forecasts

Looking ahead, corporate event data from Wall Street Horizon show an unconfirmed Q1 2023 earnings date of Tuesday, May 2, after the close, with a shareholder meeting later that month on the 17th.

Corporate Event Risk Calendar

The Options Angle

Digging into the upcoming earnings report, data from Option Research & Technology Services (ORATS) show a consensus EPS forecast of $0.74 which would be a steep 37% decline from $1.17 of per-share profits earned in the same period a year ago. What’s bullish though, is that the stock has topped earnings expectations in each of the previous six quarters and shares have traded up post-earnings in four of the previous five reports.

Options traders have priced in a 5.6% earnings-related stock price swing when analyzing the at-the-money straddle expiring soonest after the Q1 earnings report. Since shares have moved 3.2% or less in the last five reports, I’m not inclined to pay up for that premium. Going short options could be the better play. Let’s look at the chart to spot a possible trade.

RDN: Positive EPS Beat Rate, Pricey Options

The Technical Take

As I outlined earlier this year, RDN is stuck under a downtrend resistance line. I went nearer term with this look, but the same thesis holds. Shares remain neutral on technicals so long as the stock is under the trendline off the early 2021 peak, but I’d like to see the stock rally above that $25.31 peak in order to help confirm a bullish reversal, too. I see support, however, just under $18, so buying the dip to that level is the smart play.

As for the earnings release, selling the $25 upside call while selling the $18 put could take advantage of premium that I see as expensive. With a 200-day moving average that is flat, that’s just further evidence that there is no clear price trend in place but shares of this financial sector stock did not break down during the March banking crisis like so many others, so that is a positive sign.

RDN: Trading Range Continues, Muted March Volatility

The Bottom Line

I see modest upside to Radian here, but a strong earnings report in May along with a price breakout could be key positive catalysts.

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