Description

First America Financial Corp (FAF) offers an attractive opportunity for long-term investors.  FAF is a $6.2 billion market capitalization title insurance company that also offers settlement services and other risk solutions.  Management asserts that the company has a 25% market share in the domestic title insurance industry in addition to operations in seven other countries.  The investment thesis for FAF is based on the following points:

1.  The title insurance industry is likely operating near trough conditions.  The current state of the residential purchase and refinance indices is extremely depressed.  For the week ended September 8^th, mortgage applications hit their lowest level since 1996.  August refinancing activity was the lowest since 1995.  Where will mortgage rates go?  I have no idea.  When will this rebound?  No clue.  What do you think recession risk is?  I think it’s really high.  Regardless, in 1995 the US had 266 million people and today the country has 335 million people.  I believe that volumes will improve at some point and that industry conditions are at trough levels.

2.  FAF is an attractive absolute value and a high quality company that generates solid free cash flow.  I believe that consensus earnings are likely reasonable and that implies a 13x PE multiple on what is likely trough earnings.  FAF is paying a 3.5% dividend yield and has repurchased $152MM in stock over the last twelve months.
3. First American is a well-managed business that is generating solid margins in a trough environment.   Purchase and refinance markets are horrible.  Despite this, FAF has generated $445MM in free cash over the last twelve months.  The company has generated FCF each and every year since 2007 and allocates capital in a thoughtful manner.  Management has noted that despite the incredibly depressed volumes, they expect to generate a title insurance margin of 10% in 2023.  In historical troughs, profitability was much lower.  This points to a business that is poised for outsized profitability when the cycle inevitably turns. 

Operations

First American provides title insurance, settlement services and other financial services and risk solutions through its title insurance and services segment as well as its specialty insurance segment.

Title Insurance and Services – FAF’s title insurance and services segment issues title insurance polices on residential and commercial property in the United States and internationally.  Other primary services include:

• Providing closing and escrow services
• Accommodating 1031 exchanges
• Providing and maintaining access to title plant data and records
• Providing appraisals and other valuation related services
• Provide lien release and default related services
• Warehouse lending and sub-servicing of mortgage loans
• Providing banking trust and wealth management services.

On a year-to-date basis this segment accounted for 83% of revenues and 87% of pre-tax income before the allocation of corporate costs. 

FAF conducts their title insurance and closing business through a network of direct operations and agents in 49 states, the District of Columbia, Canada, the U.K, Australia, New Zealand, and South Korea.  The purchase business is obviously very seasonal while the refinance business is less so.  FAF provides services to both residential and commercial customers. 

The title business is a data business and management notes that their title plants are their most valuable asset.  A title search generally utilizes public records or a title plant holding information abstracted from public records.  Public title records are indexed by names while their title plants are arranged geographically and are considered more efficient.

Of note, First American does have a federal savings bank subsidiary that offers trust, wealth management and other deposit services.  They do not have a lending arm.  The bank had balance sheet assets of $6.7B at year-end 2022.  Deposits were all funds of affiliates.

Home Warranty – The Home Warranty segment provides residential service contracts for residential systems including heating and air conditioning and other appliance failures.  The business operates in 35 states and the District of Columbia.  Year-to-date revenues and pre-tax income accounted for 17% of revenues and 13% of pre-tax income.

Financials

First American generated GAAP EPS of $6.16, $11.14, and $2.45 in 2020, 2021 and 2022.  Net investment gains and losses, skewed results to in my view CFO and FCF are the best metrics for the business.  2020, 2021 and 2022 CFO was $1.08B, $1.22B, and $780MM.  FCF was $971MM, $1.06B and $520MM.  Capex has almost doubled over the last several years due to heavy investment.  If capex were normalized, FAF would be generating approximately a 10% FCF yield on trailing numbers.  Consensus EPS estimates are $4.24 and $5.28 for 2023 and 2024.  I believe these are conservative alhtough they will be dependent on residential and commercial volumes.  

The balance sheet is clean with debt to capital of 29.2% or 22.5% is one excludes secured financings payable.  While the business is depressed due to higher mortgages rates, management noted that they could potentially see $600MM this year in annual investment income due to higher interest earned from their investment portfolio.

Management

Ken Degiorgio has been CEO of the company since February of 2022.  He has been at FAF since 1999 and has worked in both legal and financial positions.  He has an undergraduate degree from Harvard College, an MBA from UCLA and a JD from The University of California Berkeley School of Law.   Mark Seaton has been the CFO of the company since 2013.  He first joined the business in 2006 and served as Director of Investor Relations.

Risks

• Continued depressed housing activity
• A spike in claim costs
• Poor capital allocation.

Catalyst

- A rebound in commercial and residential real estate transactions from trough levels

-Management delivering on 10% Title Segment margins at the trough of the cycle