American Capital Agency: Stock Buybacks Key To Stock Appreciation And Increasing Dividends

Jan. 3.14 | About: AGNC Investment (AGNC)

2014 will be a strong performance year for American Capital Agency Corp. (NYSE: AGNC). AGNC bought 43 million shares during 2013 and has stated they plan to continue as long as the stock price is below the book value. Current book value is $25.27 and the current stock price opened on January 2, 2014 at $19.06.

On December 18, 2013, AGNC announced that in the fourth quarter of 2013, it made open market purchases of approximately 28.2 million shares of American Capital Agency common stock, or 7% of the Company's outstanding shares as of September 30, 2013. The shares were purchased at an average price of $20.82 per share, including expenses, totaling approximately $586 million. Since commencing a buyback program in the fourth quarter of 2012, the Company has purchased approximately 43.0 million shares of American Capital Agency common stock for total consideration of approximately $934 million, including expenses.

One big plus from the buybacks is while the company holds the stock, the dividends are spread to outstanding stock (held by investors). This means the dollars of dividends are spread to a fewer number of shares, and a higher payout to the outstanding shares. To demonstrate an example, we will use the last dividend. The company has approximately 377 million shares outstanding. They will pay $0.65 per share which totals $245 million in payout. If the company had not bought 43 million shares, they would divide the $245 by 420 million shares for a dividend of $0.58, all things being equal. As an investor, you profited by $0.07 per share because the company bought the shares.

AGNC restructured their portfolio since last spring and has established a sizeable (and profitable) core income. Net income for the year-to-date through 3 quarters was $1234 million and 4Q should continue over $410 million. The size of the portfolio has shrunk slightly, however, the amount of money used in buybacks offset the loss and should increase the book value per share for the 4Q. With the continued buybacks, we can expect the stock price to rise closer to the book value, as the market evaluates the fewer number of shares outstanding and a better return for investors. By year end, we could see a book value near $27.50 and stock price near $25.00. We estimate the stock price will trail the book value through 2014 and into 2015 until the full impact of the interest rates increases are realized in the market.

AGNC has the ability to lower its leverage rate and maintain the size of its portfolio as it grows. Borrowing less will allow it to take advantage of more opportunities at lower costs with a lower effect from the risk of interest rates rising. The company's treasury stock holdings are near $1 trillion at $20 a share and if the book value increases to an estimated $27.50 and stock price appreciates to near $25 a share, the value would increase by 20% allowing the company to then sell and enhance buying opportunities.

The net spread between the cost of borrowing money and investing in long-term mortgages has stabilized over the 4Q, 2013, and is expected to continue by market experts. This spread helps REITs manage their portfolios more easily and keeps fluidity in the market. The net spread produced $240 million in income during 3Q, 2013 and is expected near the same for 4Q.

The Federal Reserve Board has openly stated they will maintain lower interest rates through 2014 and that will help stabilize the cost of money and the housing market. This is a key driver for not only the economy and housing markets, but allows the big banks, smaller banks and mortgage lenders to maintain the stability of cash flow. In the future (sometime after 2014), the Feds may allow interest rates to rise, but will manage a slow increase to balance with the economy and markets. The Federal Reserve Board has become a much better manager that better defines standards and business operations to Wall Street which translates to working for Main Street.

CEO Malon Wilkus and President and CIO Gary Kain have done an excellent job in positioning AGNC for the future. Profits and dividends of the past were appreciated, but the work to set the company up for a bright future has not yet been acknowledged. The buybacks will allow the company access to large blocks of cash when opportunity presents itself. When the market changes in 2015/16 with the Feds decrease in buying of bonds and the increase in interest rates, the company will be well-positioned to take advantage.

A look at the technical data on AGNC shows although the stock price has dropped below $20, the value is there and the stock is oversold. The company usually releases its quarterly report (and the annual report near the end of the first month after the quarter ends. AGNC should present a strong quarter and solid for the year. The slide in the stock price from a high of $33.31 to $19.29 through 2013 was tough for investors, but we can see the floor with an expected rally through 2014. Between the stock price appreciation to $25 would represent a 30% increase and dividends would drive the return over 40%. That is much needed compensation for investors who rode the storm in 2013.

Our assessment is AGNC will have a solid performance year for 2014, because the leadership has created opportunities by buying 43 million shares in 2013 and has positioned the company for a flexible 2014. AGNC is one of the largest REITs and will grow more productive in 2014. We anticipate at least a 10% appreciation in the stock price and double-digit return in dividends. The biggest negative has been averted by the Feds with their intent to keep interest rates low.

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Disclosure: I am long AGNC. 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.