ARMOUR Residential REIT (NYSE:ARR). What a conundrum. As you are aware I have followed ARMOUR Residential REIT and have been extremely sour on the name for some time. I have urged investors against jumping in despite the massive discount-to-book for over a year. In this sector, things do change rapidly. I recently gave the name a little bit of praise following its Q4 report, and perhaps I spoke too soon. A certain analogy of wrapping animal droppings in a thin coat of a precious metal comes to mind. You figure it out. I stated in the article that "I think ARMOUR has started to turn the corner". I went on to say "all I ask in a name is for dividend coverage without massive book value erosion". Now as we know so much of this can be beyond the company's control (e.g. prepayments, interest rate movements) but the company can try to position itself appropriately given known and predicted circumstances. But to me it's about the dividend, and that is why we own REITs.
The reason I have been so negative on the company is because ARMOUR had been having issues covering its dividend quarter-after-quarter, resulting in multiple cuts. I felt the company was turning the corner because Q4 was the second quarter in a row the company out-earned its payout. In three quarters it went from failure to cover the dividend, to barely covering dividends, to covering dividends, resulting in so-called "spill-over." I was pleasantly surprised with the Q4 results but I have to say even though it was telegraphed by management the company has just confirmed it will cut its payout AGAIN.
The stock isn't reacting because management has said this cut was coming. But I want to address the fact that this cut came at a time when the company managed to outearn its payout. Now make no mistake the company certainly has a major financial commitment in its purchase of Javelin Mortgage Investment (NYSE:JMI). Rest assured ARMOUR will sell off the assets to raise cash quickly for more appropriate redeployment. Still, as a shareholder this means you just got an 18% reduction in your payout. Moreover, the stock was nearly yielding 20%, but now is back down to historical norms of a 15% yield.
This cut could be just be for the month. The company declared just the month of April's common dividend of $0.27, down from $0.33. It is payable April 27th for shareholders of record April 15th. It goes Ex-dividend April 13th. Simultaneous the company also announced its Preferred shares will be paid as usual, with no cut of course. That is why I have been recommending the Preferred shares in many of these mREITs. If you can get them at a discount-to-par, it's not a bad play.
As far as making an investment goes, I am not ready to make that call. I'd stay away. Too many moving parts here and let's face it the track record speaks for itself. I don't want to own a name that is constantly cutting dividends. I want sustained dividends that are covered. This is why I am peeved. The company put out its second rather strong quarter relative to the sector as a whole in a row. This follows almost two years of lagging the market. Core income, a great measure for determining income available to pay dividends, came in at $47.7 million, which was $1.10 per share. This was however down quarter-over-quarter from the $52.4 million, or $1.11 per share in Q3. The reason for the per share earnings being nearly flat was due to the company's buyback. Core (plus drop) income was far more than enough to cover the dividends. Remember, the company paid dividends of $0.99 per common share of record for Q4 2015, resulting in payments of approximately $39.5 million. Let's say this cut isn't for just this month and the company keeps a $0.27 payout. That would mean the company would payout just $0.82. I think it can do this, barring catastrophe.
The reason I see the dividend being covered is that in the fourth quarter, the annualized yield on average assets jumped to 2.71% up from 2.56% in Q3. Further the annualized cost of funds, was 1.13%, essentially flat from Q3. This led to the net interest spread widening to 1.58% from 1.44% This is still quite low in the mREIT sector, although it's higher than some competitors in the space. But the key is that it is widening. Let's not forget though that book value continues to erode. Recall in Q3 it fell to just $29.05. It was down again another 3.5% to $28.00 in Q4. While the stock trades at 25% discount-to-book, I am still cautious because I see no signs of the bleeding stopping.
Despite the significant improvement performance wise, the dividend cut and now the added variable of the JMI purchase makes this name even more unpredictable than it already was. Yes, I do think that the company is turning the corner but I do see continued prepayment pressure thanks to an uptick in refinancing of late. At this point I can't blame anyone for making some cherry-picking buys in the name, but I am not a buyer. Sustained performance with a consistently paid and covered dividend with stabilization in the book value could change my mind.
Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
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