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By Siraj Sarwar

American Capital Agency (NASDAQ:AGNC) is one of the most popular stocks among income-oriented investors. As a mortgage-backed real estate investment trust, AGNC invests in collateralized mortgage obligations and agency pass-through securities.

While macroeconomic risks remain elevated, American Capital Agency announced that it would maintain its massive quarterly dividend of $1.25 per share. In this article, I look at the company's dividend profile, third quarter results and the stock repurchase program to see where it stands in the industry.

Dividend Profile

American Capital Agency is a nifty cash generating machine. The company sustained dividends of $1.40 for ten quarters. However, due to volatile macroeconomic circumstances, the company reduced dividends by 10.7%. Recently, the company announced a quarterly dividend of $1.25 per share for the fourth quarter.

Still, AGNC is paying one of the highest distributions in its peers group. One of its closest peers, Annaly Capital Management (NYSE:NLY) is paying a dividend of $0.45 which yields about 13.81%. I believe the Fed's low rate interest policy will impact favorably to these companies' business models.

Third Quarter results

American Capital reported third quarter earnings of $1.3 billion or $3.98 per share. Currently, the company's stock is trading at $31.50 per share. At the moment, the company is trading below its fair value. At the end of Q3, the company's net book value increased to $32.49 per share. This is an increase of $3.08 per share from the earlier quarter. In the previous three quarters, the company increased its book value from $26.9 to $32.49 per share. In addition, the company launched shares repurchase program of $500 million. It is obvious from the repurchase program that the company thinks its share is undervalued.

On the negative side, the taxable earnings per share went down by 26 cents at the end of the third quarter. Taxable EPS decreased due to the contraction of spread rate. The company's spread rate had fallen from 1.62 to 1.5. However, American Capital Agency is switching its portfolio holdings to lower coupon mortgage-backed securities. Moreover, Fed's expansionary monetary policy can also help the company to increase spread rates.

Repurchase Program

The company's Board of Directors has authorized the repurchase program of $500 million of its outstanding shares. The company will purchase shares at a discount. When a company repurchases its stock at a discount to book value, it raises the per share book value of the outstanding shares.

Buybacks are immensely valuable for investors and stockholders. Shares repurchase program offers several benefits. It can decrease assets on the balance sheet, which translates into higher return on equity and assets without any alterations in profit. Share repurchases further drive down its valuation ratios such as price-to-earnings ratio. A lower price-to-earnings ratio means that the company's stock looks cheaper than it was prior to the buyback.

As far as stockholders concern, buybacks can hike the price of stock by increasing demand for the outstanding stocks. Buybacks can also help the company to increase its dividends. The decrease in outstanding shares can lift both dividends per share and future dividend yields.

Competition

Besides the FED itself, the biggest competitor for American Capital Agency is Annaly Capital Management. The following table lists important metrics of these two mREITs.

 

AGNC

NLY

Industry average

P/B

1.0

0.9

1.9

P/S

10.4

8.3

8.1

P/E

12.5

10.4

35.1

Dividend yield

16.1

13.95

-

Debt/Equity

-

0.1

-

Rev Growth%

175.4

10.2

5.3

Operating margin%

84.1

85.6

32.8

Net margin%

83

81.0

28

Source; Morningstar.com

American Capital Agency is trading at attractive price multiples. The company has solid margins and growth potential. In addition, the company's yield is the highest among its peers group. Analysts have a mean target price of $34.5 for American Capital's stock. The stock currently trades below its book value and offers a nifty yield of 15.8%.

Summary

American Capital Agency invests exclusively in agency-backed securities. Moreover, it owns mortgage-backed securities at low coupon and low balances. Most of the company's portfolio is prepayment-protected.

Recently, the company shifted its portfolio holdings to HARP securities and lower coupon mortgage-backed securities. This initiative can protect its portfolio from prepayment risks. This move in the portfolio can also lower the impact of decreased net interest rate spreads. I believe these initiatives can shield the company's double-digit dividends against Fed's unfavorable policies at least for the next few years.

Source: American Capital Agency: Recent Moves Can Shield Against Strong Headwinds