Potential Inclusion In The S&P 500 Index Could Cause Annaly Shares To Jump

Jul. 5.13 | About: Annaly Capital (NLY)

Annaly Capital Management, Inc., (NYSE:NLY) shares were trading around $15.50 in April, but concerns over the Federal Reserve's plans to taper, and a rise in interest rates have pressured the mortgage REIT sector enormously. Shares of this leading mortgage REIT are now just about $12 and there is still much uncertainty over the impact and timing of tapering and the possibility of additional big moves in rates. Just look at the chart below to see the type of devastation stocks like Annaly have experienced.

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Annaly Capital is a leading mortgage real estate investment trust and as such, it pays the majority of its earnings out to shareholders in dividends. When companies have a high payout ratio, a drop in earnings can lead to dividend cuts rather quickly. It is interesting to note that a few months ago investors were concerned that mortgage REIT companies would be hurt by QE3 as this bond buying program caused rates to drop, which then led to refinancing activity. When a homeowner can get a lower rate by refinancing, this can mean higher yielding mortgages get paid off which can reduce profits for companies like Annaly. However, investors are now concerned about the rise in interest rates since that has impacted the value of mortgage bonds which are held by companies in this sector. The best thing would be for rates to remain stable and that could lead to a rebound for Annaly, but there is another potential positive that could boost the stock.

There are some pending merger and acquisition deals that will lead to the removal of some financial stocks from the S&P 500 Index (NYSEARCA:SPY). This means that new stocks will need to be added and analysts at Keefe, Bruyette & Woods, feel that Annaly Capital has the potential to be added to the index. They also estimate that an inclusion in this index would lead to the purchase of about 122 million shares of Annaly, which is equivalent to roughly 7 days worth of trading volume. A recent Barron's article sums up the potential for Annaly to be included in the S&P 500 Index and the positive impact this could have on the stock; it states:

"From this point, the analysts make the argument that it's time for a mortgage real estate investment trust, which became eligible for S&P 500 inclusion this year. Their candidate for the job: Annaly Capital Management, which could see a price bump from indexers' demand if KBW's view wins out.

The logic for Annaly over American Capital Agency Corp. (NASDAQ:AGNC) boils down to a longer history as a public company, a bigger market cap, and deeper trading liquidity."

While any inclusion of Annaly in the S&P 500 Index is far from certain, it could be a real positive since it would spark a major round of buying from ETFs and mutual funds that track the index. This could give the shares a much needed lift. Even the possibility of inclusion in the index could start to provide some support for the stock in the coming weeks. However, additional downside risks include a potential dividend cut (although that might already be priced into the stock at current levels). Analysts expect the company to earn about $1.45 per share, but with the dividend at $1.60, another cut might be needed. Even if the dividend is reduced, it might not be by much, and with a dividend that yields so much, and the potential bonus of inclusion in the S&P 500 Index, it might even make sense to buy this stock near 52-week lows.

Here are some key points for NLY:

  • Current share price: $12.13
  • The 52 week range is $11.99 to $17.75
  • Earnings estimates for 2013: $1.45 per share
  • Earnings estimates for 2014: $1.44 per share
  • Annual dividend: $1.60 per share which yields 12.7%

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.