But rather than investing in homebuilders like KB Home (KBH) or DR Horton (DHI), or even the SPDR S&P Homebuilders ETF (XHB), I think I've found a better way to go...
Just like car insurance, title insurance is a necessity for buying a home. A buyer is required to purchase the insurance to protect against a prior ownership claim that would make a sale impossible. These claims can arise from forgeries, misrepresentations, incorrect legal descriptions and even simple errors made when closing on a house.
Simply put, this is a business that benefits every time a home is bought. And the great part about it is that claims for title insurance are rare, so the companies in this industry pocket most of the premiums. One company, in particular, looks to be the best bet for investors.
Fidelity National Financial (FNF) has used the historic downturn in the housing market to its advantage. In late 2008 it acquired many assets from archrival LandAmerica, which had fallen into bankruptcy as a result of the housing collapse that began to build steam in 2006. The LandAmerica units folded into Fidelity National's existing franchises (Fidelity National Title and Chicago Title) were stodgy but important names, such as Lawyers Title Insurance Corp., Commonwealth Land Title Insurance Co. and United Capital Title Insurance Co.
Fidelity National now lays claim to being the largest title insurance company in the nation, with a market shareclose to 46%. The company's scale helps it lower costs and better manage cyclicality in the housing industry, as the industry is still recovering from the bursting of what will likely turn out to be the biggest housing bubble in history. Residential title insurance constitutes the majority of Fidelity National's business, though it also operates on the commercial side of the market.
Provisions for claim losses only made up 7% of Fidelity National's total expenses last year. Personnel and other costs to operate 1,600 offices and pay sales commissions to 7,500 insurance agents across the United States are substantial, but profit margins (in the mid single digits) are still respectable and should rise as synergies from the LandAmerica acquisition are realized.
The firm remains solidly profitable during a difficult operating environment and still had enough cash to raise its dividend to $0.18 a share last quarter, equating to a trailing yield of about 5.0%. Better yet, its leadership position in the industry means it will garner the lion's share of an upturn and will eventually see a solid boost to operations once the industry stabilizes to more historic levels. Additionally, Fidelity National plans to boost its specialty insurance lines, such as flood, home warranty and other personal lines. These businesses are generally smaller but can be very profitable.
Fidelity National should continue to consolidate market share. LandAmerica will likely be the largest and most opportunistic deal the company ever makes, but future deals are not out of the realm of possibility. Fidelity National has a history of acquisitions aside from Land America, such as when it bought Chicago Title in 2000 -- in the midst of another market downturn. New deals are unlikely to have a dramatic impact given Fidelity's size, but bolt-on acquisitions can easily add a couple of percentage points to organic growth.
Action to Take ---> In terms of valuation, Fidelity National currently trades slightly below its most recent quarter-end book value of $14.46 a share. That means investors are essentially paying nothing for future earnings that Fidelity National posts. Earnings are unlikely to come close to the more than $3 a share earned in 2005, but the addition of LandAmerica's assets and an inevitable improvement to industry conditions could easily send the company's return on equity (ROE) back to the double digits. An improved ROE equates to about $2 in earnings, and a low double-digit multiple off those earnings implies the stock can eventually double from current levels.
An investment in Fidelity National requires a bit of patience because the housing market has yet to show signs of a sustainable recovery. Glimpses of growth abound, but May was a horrific month in terms of new sales due to the April 30th expiration of a government homebuyer tax credit. It won't be long before real estate activity perks up for good, which could send Fidelity National's stock up significantly.
-- Ryan Fuhrmann