Good Time To Buy And Hold ARMOUR Residential REIT

May.26.14 | About: ARMOUR Residential (ARR)

Summary

Financial statement strong on earnings and dividend over 12%.

Downside included reduction in book value and an increase in the leverage ratio.

Bottom line puts cash in your pocket - buy and hold.

We rate ARMOUR Residential REIT, Inc. (NYSE: ARR) as a buy and hold. The dividend is sustainable based on the first quarter's financial report (see the company's website) and our review of the technical data and analysis. ARMOUR restructured its portfolio to move into a hybrid style investment. The company added hedge-type investments to level the peaks and valleys in the market. In doing so, we see a more linear projection in the returns rather than more highs and lows each quarter. The company will continue to assess and adjust their portfolio to get the right mix over time. The company's intent is to prevent another jolt (like in May 2013), where the company and market as a whole suffered a 30% drop in stock price value.

The first quarter average net interest rate margin of 1.82% compared against 1.35% from the quarter one year ago. This is largely due to the increase in the average yield on assets of 3.19%.

On March 6, 2014, the company authorized the repurchase of up to 50 million shares of common stock. The average volume of shares traded over the last 30 days has been over 4 million shares per day with a steady range between $4.15 and $4.28.

The company issued 19,463 shares of common stock during first quarter 2014 under its dividend reinvestment plan. Currently, there are approximately 357 million shares outstanding. During the quarter ending March 31, 2014, the company repurchased 600,000 shares of outstanding common stock for approximately $2.6 million. The company reduced the total count of common shares by 580,537, after the buy back during 2013 of 13 million shares.

One method to increase your portfolio is to automatically reinvest your dividends like many investors did above. You gain additional shares in the company (without investing more of your money) and you continue to grow your investment at the double-digit rate of the dividend.

One of the negatives ARMOUR reported was the book value decreased to the per share sum of $4.67 in the first quarter. This compares down against $4.75 in the fourth quarter, 2013 and against $6.69 per share first-quarter 2013. Had the company reinvested the $2.6 million instead of repurchasing shares, the company's portfolio would have grown. The company will need to reverse this trend and show investors they can grow the book value and provide solid, double-digit dividend returns. We anticipate the company stabilizing the book price in 2014 through adjusting the company's portfolio and adjusting their hedge investments. The company began investing in hedges last fall and is still modifying to get the right mix. As noted above, as the company moves through the summer housing period, the market will remain stable and interest rates will show little change.

Also in the financial report, the company's leverage ratio as of March 31, 2014 was 8.12 to 1. Reported during the fourth quarter, 2013's financial report was the leverage ratio of 6.92 to 1. A jump to over 8% is higher than most other REITs and will need to be monitored for changes in the future. Once again, the stock repurchase money could have been used to purchase new investments, or pay off some of their debt that is driving the leverage ratio up. We expect the company will modify their investment operations and bring the ratio under 8% over the next quarter. It is a concern, not a deal-breaker for this investment.

It is important to add (because the government can quickly and greatly influence the mortgage markets and interest rates) that the Federal Reserve has been quietly doing nothing to affect the markets and the interest rates. Multiple reports from the Federal Reserve over the last 6 months have discussed the need for stability in the markets. The Feds intent to keep interest rates low for the rest of 2014 and into 2015.

This was a mixed quarter with positive earnings, some buy back of shares and the dividend payouts (supported by earnings) of approximately 12% were good. The down side was a reduction in the book value and the increase in the company's leverage ratio.

Our recommendation is to hold or increase your holdings of ARR. The annual and quarterly reports continue to show profitability and the company is paying dividends in excess of 12%. We see the company paying a catch-up dividend sometime in the fall as they execute a profitable year and need to increase their dividend to maintain their REIT status.

ARMOUR's first quarter's financial report highlights the taxable and core income of $58.3 million. Using the first-quarter report and some technical deep dive into the numbers we determined there are sufficient indicators to sustain the company's operations and produce a continuing profit each quarter for the company. The core income and estimate taxable REIT income of $58.3 million equate to a $0.15 per common share dividend return that represents a 12.28% return on stockholder's equity for the quarter. The macro housing market in the U.S. demonstrates a slight growth nationwide and the interest rates are stable. Both of these are excellent signs for the summer housing turnover.

The difference between ARMOUR's core and GAAP income are seen in the addition of gains from the hedges and the one-time gains from sale of agency securities. The company posted a $153 million gain from the change in the fair value of its derivatives, while earning $69.9 million from the sale of agency securities. Furthermore, the company posted other gains and losses related to premium amortization for around $5.0 million (see the first quarter financial statement for the more detail).

ARMOUR's self description on their homepage: "ARMOUR Residential REIT, Inc. invests in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage-backed securities issued by or guaranteed by U.S. Government agencies or U.S. Government sponsored entities such as: the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation, (Freddie Mac)."

Disclosure: I am long ARR. 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.