New Residential: How Safe Is The 17% Dividend Yield?

| About: New Residential (NRZ)

Summary

New Residential pre-announces extremely strong Q4 results.

The dividend is more than covered by core earnings.

New Residential also announced a large $200 million share buyback program.

The dividend yield is now above 17%.

From its trading action, you would think New Residential Investment Corp (NYSE:NRZ) is soon going out of business. The share price has been cut by 40% since mid-2015 despite the company not showing any signs of weakness in its core operations. This has pushed the dividend yield to above 17%, indicating growing skepticism on its sustainability. However, given the preliminary Q4 results, the market is unjustly punishing this name.

A look at the numbers

New Residential is expecting Q4 core earnings to range from $0.49 to $0.53 per share, compared to $0.49 per share in Q3 and $0.41 per share last year.

As for GAAP earnings are expected to range from $0.43 to $0.47 per share in Q4 and $1.31 to $1.35 per share for the full year, versus $0.24 in Q3 and $1.01 per share last year.

These numbers imply core earnings growth of up to 8% Q/Q and 30% Y/Y, while GAAP earnings show growth of up to 88% Q/Q and 34% Y/Y.

These are outstanding numbers and show that New Residential's business is growing profits at a brisk pace. These are also inline to above New Residential's own guidance, which called for an earnings run rate of ~$2.00 per share by the end of 2015.

It appears New Residential benefited from gains on its non-agency paper while its MSR business did well due to rising rates and lower prepays. I'll have more specifics and details when New Residential's full Q4 report is out.

Dividend is set to grow, not fall

Given that New Residential's earnings are growing, it stands to reason that the dividend will as well. The company declared a $0.46 per share dividend for Q4, inline with the Q3 dividend.

This implies that the Q4 dividend payout ratio could be as low was 87% of core earnings. This is below New Residential's historic payout ratio as the company aims to distribute nearly all of its core earnings to shareholders. In other words, the current dividend appears sustainable.

Assuming the dividend rises alongside earnings at a similar rate, New Residential's next quarterly dividend could be as high as $0.50 per share, or about a 19% yield.

Buyback may have a huge impact

Lastly, a few words on New Residential's buyback plans. The company announced that it is looking to repurchase up to $200 million of its stock. This is good for ~8% of the float at current prices.

Buying back shares makes a ton of sense for New Residential given that its book value is hovering ~$12.18 per share. This implies that the stock is trading at a ~13% discount.

Though I would not want to see New Residential sell assets to fund the buyback. If the Q4 results are any indication, the core business is booming. Furthermore, unlike most mREITs, New Residential's assets are not the highly liquid agency MBS and thus cannot be sold quite that quickly.

Conclusion

While the price action in New Residential has been disastrous, its underlying performance could not be better. It is quite irrational that this is a stock that grew at a 30% rate and yet trades at well below book value while yielding over 17%. I recently added to my position.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Disclosure: I am/we are long NRZ.

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.