- The Annaly Capital's quarterly 8k earnings report was a major positive surprise.
- The evolution of the commercial business is a growth catalyst.
- Book value dipped, but share price momentum has an upside bias.
Thus far, I have been lucky enough to call a bottom on the share price of Annaly Capital, and have jumped all over the stock at roughly 9.80/share, as I noted in this article. I followed it up with a rather prophetic article just last month as well
The sector and the stock will still face headwinds of course, (rapidly rising rates, mortgage slowdowns, pre-payments, etc.) but I found that the earnings report was quite compelling for further upside, and sooner rather than later.
The Key Takeaways
Directly from the 8k itself:
As far as I am concerned, the most important component of these highlights is the doubling of the commercial investment portfolio. Since the buyout of CreXus last year, shareholders have not seen the accretive value of the acquisition, and going forward, NLY will be a hybrid of sorts. Not relying 100% on residential mortgages is a major positive in my estimation, and could drive revenues and earnings far into the future.
Fourteen percent of shareholder equity is now represented, and I would anticipate that number to come close to doubling by the end of this year. If it does, there will be even less reliance on the residential sector, and more stability of ongoing revenues. Especially as the economy continues to slowly improve.
Core earnings of $.35/share more than covers the current dividend I believe, and as that number improves, it bodes well for dividend stability as well as a very real potential for dividend increases later this year.
Lower Leverage Means Greater Flexibility
Leverage decreased from 6.5 to 5.0, and as it clearly states in the 8k itself:
the lower leverage stance permits us to be more opportunistic with capital deployment to strengthen earnings in future periods.
Some might see this as being too loose during a rising interest rate environment, as this Seeking Alpha market current points out:
- An interesting exchange took place between BofA analyst Ken Bruce and Annaly chief Wellington Denahan on today's earnings call (transcript) in which Bruce politely wonders if management - having sold low last year - isn't setting itself up to buy high this year. "I guess I am a little shocked," says Bruce. "It just feels like the market is being seduced back into thinking everything is maybe not as strong as we thought it was just a couple of months back."
- To review: Annaly showed particular caution late in 2013, taking down leverage (5:1 at year's end vs. 6.5:1 a year earlier) and boosting hedges, and now - with bond prices having marched higher in the year's opening weeks - management is talking about being aggressive again, but not planning on increasing hedges as assets are added.
I fail to see the "shock", as it is my opinion that since the tapering has taken place, the rise in rates has been very slow, and the 10 year treasury has even backed away from the 3.00% range that everyone was fearful of.
If NLY can utilize its improved spread (32 basis points) while these rates are virtually stable and go a bit further out on the yield curve, I believe shareholders will be pleasantly surprised as 2014 moves along. One other factor will be the reduced cost of hedging that Denahan spoke of in the earnings call. That will show up directly on the bottom line, further enhancing shareholder value down the road.
The Book Value Dipped, But Not That Much
While NLY reported a decline in its book value from $12.70 to $12.13, the decrease was less than 4.5% as compared to American Capital's (NASDAQ:AGNC) decline of between 5.5-8.2% (including 2.7% decline in economic return to shareholders). That being said, the share price momentum has shifted since I called the bottom, and the gap between the share price and book value is closing.
In the short term, based on the share price of $11.10, I believe that a 10% gain in capital appreciation can be achieved in the short term (3-6 months), if not more.
When I add all of this up, I am a buyer at the current share price, up to $12.13/share and perhaps another 5% for the dividend stability. At that price, the yield would be roughly 10%, and maintainable.
The Bottom Line
While I already own NLY, I am adding and have added shares to a full risk position with a 4% allocation. As a dividend investor, I am taking advantage of the yield, a stable dividend, and the potential capital appreciation to boost my overall returns.
Keep in mind that if the interest rates were to jump too quickly, I might just head for the hills.
Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. Please remember to do your own research prior to making any investment decisions.