Australia has been in the midst of a property boom since 2012, with lenders, brokers and real estate agents reaping the benefits of favourable tailwinds caused by low interest rates. Mortgage Choice Limited (ASX: MOC) was one such beneficiary of the property boom, with the stock doubling in price over this time.
However, the company's share price has recently slumped 23%, underperforming the broader market.
I believe it is currently underpriced for the following three reasons:
1. Business model
Mortgage Choice is an aggregator of franchises; it does not own any broker firms itself. The company receives advertising and royalty fees for providing centralised services to franchise owners.
The model is a win-win scenario for Mortgage Choice as it provides annuity style revenue from franchise owners (who are incentivised to perform because they own the business), without incurring demanding overhead costs. In return, Mortgage Choice provides scale to franchise owners by using its size to negotiate better rates for customers, making it more competitive than traditional banks.
2. Industry outlook
Part of the reason for Mortgage Choice's underperformance has been the Australian Prudential Regulatory Authority's (APRA) measures to curb investor lending in order to cool property prices. The APRA measures limit the amount of loans the banks can make for investment purposes (amongst other things).
The measures appear to be working, with August figures revealing total lending growth slowed to 3.4% and investment lending fell 0.4% for the month. Investors have become fearful of the outlook for the industry, adding to the woes of Mortgage Choice's share price.
3. Stable income
Despite the outlook, Mortgage Choice should be largely unaffected by the slowdown. This is because brokers generate income on a commission basis. Mortgage Choice brokers receive an initial commission for writing a loan and then a trailing commission on each anniversary the loan remains in existence. The trailing commission is paid as a percentage of loan book value. Accordingly, mortgage brokers continue to derive income from writing loans long after the loan is settled.
In its August results, Mortgage Choice had a loan book of $49.5 billion, which should continue to deliver sufficient income to maintain the current dividend of 15.5 cents per annum.
Foolish takeaway
Despite a slowdown in lending, Mortgage Choice should be insulated from profit decline given its annuity-style business model. With the company currently trading on a fully-franked yield of 12.4%, which should be maintained from its trailing commissions, Mortgage Choice appears under-priced at current levels making it an excellent stock to buy in a rising market.
