As the U.S. and world economies continue to move in fits and starts amid the coronavirus recession, investors are wondering what will happen if we see a resurgence in the disease that causes a further shutdown of business. Here are three stocks that could do more than just survive a recession; they could actually benefit from one.
Buying bad debt at pennies on the dollar
PRA Group (PRAA -0.03%) is a bad-debt collector. Recessions generally mean an ample supply of nonperforming loans, which PRA buys from banks and other creditors and then collects itself. Last year, PRA Group purchased $11.7 billion in receivables for $1.3 billion, which means it was paying 11 cents on the dollar.
Banks have taken large reserves for bad loans due to COVID-19, which means we should start seeing delinquencies pile up. Surprisingly, PRA said in its second-quarter earnings release that collections were particularly strong. This makes sense for a few reasons. The fiscal stimulus out of Washington is one; another is that people are simply spending less on entertainment and travel due to the pandemic. For a debt collector, this is good news.
On the other hand, PRA expects to see banks begin to offload nonperforming debt late this year and early next year. This means it will have the opportunity to restock its portfolio with new nonperforming loans.
PRA's stock is trading at 13.5 times expected 2020 earnings per share (EPS), and is expected to grow EPS by 10% in 2021. If we get another recession, PRA Group should have plenty of opportunities to deploy capital. And if we don't get one, and collections remain strong, it could still represent good value here.
Investor fear means more fees
Intercontinental Exchange (ICE 1.13%) is best known as the parent company of the New York Stock Exchange (NYSE), but it also owns some bond-trading markets and commodity exchanges. ICE is also building a presence in the mortgage market, which is going through a technological revolution partly driven by efficiency needs and social distancing.
Why would a stock exchange perform well in a recession? As a general rule, recessions and bear markets often travel together, and the increased anxiety means higher trading volumes -- in the second quarter, for instance, the NYSE's average daily volume for cash equities rose 61%, and for equity options it rose 44%. As an operator of exchanges, ICE doesn't really take much credit risk. It earns fees by facilitating trades, which simply means it makes sure the buyer has the cash and the seller has the stock.
The mortgage business is benefiting from the big technological revolution. Companies like Rocket (RKT 2.89%) are creating a technology-driven model that is exceptionally profitable. ICE owns the Mortgage Electronic Registration Systems, which is a central repository for title and note information; Simplifile, which helps originators streamline their processes; and Ellie Mae, which handles origination and sales. ICE has exposure to almost every phase of the origination process.
If we get another recession, the company will benefit from increased trading volume on the exchanges, as well as more refinancing activity as interest rates remain low. ICE trades at 22 times expected 2020 EPS and has a 1.2% dividend yield.
The stock with the Fed on its side
AGNC Investment Corp. (AGNC 0.80%) is a mortgage real estate investment trust (mREIT) that invests in mortgage-backed securities guaranteed by the U.S. government. This means the company has little credit risk; most of its risk is related to interest rates.
While the mortgage market struggled during the initial months of the pandemic, things have stabilized. AGNC cut its dividend in response to the crisis, but it admitted on its second-quarter earnings call that the cut might not have been necessary.
The stock trades with a dividend yield over 10% and has a 6% discount to book value. The company has been buying back stock at a discount to book, which will push up book value per share, along with earnings. AGNC benefits from the Fed's purchase activity in the mortgage market, which is another tailwind. If the economy weakens, the Fed's buying should increase.