CYS Investments (NYSE:CYS) declared an excellent fourth quarter that would even top my estimates, but the shares declined anyway, as the selling pressure in the sector overwhelmed the positive results. Perhaps I should start by qualifying that the excellent fourth quarter is based on performance relative to my projections for some peers. On the fourth quarter CYS Investments declared Core EPS of $.27 plus drop income of $.02 for a "Core + Drop" figure of $.29 per share. Several mREITs regularly incorporate drop income into their reported "Core EPS" measure, so this is the most comparable value.
The dividends for most mREITs should be seen as questionable for sustaining. CYS Investments declaring Core EPS (including drop income) that exceeded its quarterly dividend of $.26 by $.03 is fairly positive. It is also positive that the company was able to do it while running its hedging costs through Core EPS rather than sending the costs through book value. To demonstrate those techniques, I prepared a 5-minute guide on how to fake Core EPS. I want to stress that CYS Investments is not using those techniques.
Last time I analyzed CYS Investments, I indicated that it was a best-of-breed mREIT trading at a discount to peers. I've seen nothing that would change that opinion, and the latest results on the portfolio performance reinforce it. My models estimated that the company would end the quarter with $9.21 in book value if it had no buybacks. Instead, it ended the quarter at $9.36. About $23 million was spent on repurchasing shares during the quarter, and by my estimates, the impact was favorable to book value per share by about $.04. Even incorporating that impact, the company beat my estimates by $.11. Missing by less than 2% is still a fairly solid estimate.
Discount to Book Value
I haven't run a full analysis to estimate book value for CYS Investments in a week or two, but I'm thinking about running another set of estimates, because it looks like the discount to book value for the mREIT has strengthened further. Investors should be concerned about the relative flattening of the yield curve; however, the Federal Reserve is finally starting to discuss negative interest rates, though the chairman of the Federal Reserve, Janet Yellen, did not seem thrilled about the prospect or highly motivated to pursue that line of policy in her testimony yesterday. I spent some time analyzing her comments.
It would appear that CYS Investments may be running around a 25-30% discount to book value, which would be larger than some of its higher-cost peers that are not positioned as effectively to deal with a "lower for longer" interest rate cycle. Since CYS Investments has been actively buying back shares at substantial discounts, it indicates favorable performance on the combination of book value plus dividends for future periods.
Thoughts on Relative Attractiveness
Since the end of the quarter, the interest rate developments (lower for longer) should have been better for CYS Investments than for many competitors. Despite that, the company appears to be trading at a larger discount. I can't see a good argument for the relative pricing to continue, which makes me positive on CYS Investments.
Benefit of Internal Management
CYS Investments doesn't just have a lower-cost operating structure than most peers, it also has an internal management system that rewards management based on delivering returns to shareholders rather than assets under management or some definition of "equity". As a result, management is rewarded for activities such as repurchasing shares at substantial discounts to book value rather than punished through lower fees.
This creates a significant incentive for them to be selling off parts of the portfolio and buying back shares to drive book value per share up. Higher book value per share means higher interest income per share, all else equal.
CYS Investments had a fairly strong performance, but declined with the rest of the sector. At the present time, it appears the company is still trading at a materially larger discount to book value than peers despite being more willing to repurchase shares, having low-cost management, and having a portfolio designed to withstand this type of environment. I'm contemplating buying some shares or sitting on cash and modeling frequently to see if even stronger opportunities come up.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CYS over 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.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.