Real Estate: Behind the Scenes
The US real estate industry is one of the largest components of the US economy. The industry is cyclical and depends heavily upon economic growth and demographic trends. The level and volatility of interest rates strongly affect the industry. For example, real estate prices skyrocketed during the past decade due to rising demand and low interest rates. Residential construction and sales of existing homes remained strong during 2000-2005. However, by the end of 2006, the residential market slumped and prices started to decline as a result of the subprime mortgage crisis and a broader economic slowdown. This culminated in a nationwide crash in real estate values that has since leveled out and begun to slowly strengthen.
Tighter credit and declining prices throughout the US that damaged the industry have begun to reverse course. The market has experienced a period of high delinquencies and foreclosures, which has resulted from the wide scale price collapse. Many homes are under foreclosure proceedings or are now owned by lenders. Also, the commercial real estate market has witnessed a spillover impact from the decline in the residential market.
The US real estate industry is comprised of real estate investment trusts (REITs). A REIT is a corporation or trust that uses pooled capital to issue mortgage loans to builders/developers or directly invests in income-generating property that offers tax benefits with respect to interest and capital gains. REITs are typical broken up into three categories: equity REITs, mortgage REITs and hybrid REITs. Equity REITs take up around 90% of the market, owning properties and generating revenue through the rental and sale of property. The debacle of 2008 has made it much more challenging for REITs to access capital via public debt and equity markets.
Money to be made through REITs
There is definitely money to be made by jumping on the bandwagon and investing in real estate, whether you are physically purchasing land and/or property, or simply investing in real estate companies, much like REITs. The latter option is much more popular and often easier. Investors are able to allocate their money into an individual REIT of their choice, and sit back, not having the responsibility of underwriting, valuing, negotiating ad managing the individual properties. Various powerhouse REITs across the world, such as Vornado (VOR), Ventas, Inc. (NYSE:VTR) and Digital Realty Trust (NYSE:DLR), have shown how competitive the industry is, they are heavily funded and consistently outbid and outplay the small, weaker firms. Essentially creating an oligarchy when it comes to bidding on the best and most profitable assets. In this article, I am not going to focus on these powerhouse firms which maintain constant acquisitions and revenue year to year, rather focus on a REIT, which has struggled in the past, but has finally fallen over. Enter American Capital Agency Corp. (NASDAQ:AGNC)
Bye Bye American Capital Agency Corp.
The company specializes in investments on a leveraged basis in agency mortgage-backed securities. The company's investments consist of residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by a government-sponsored enterprise, such as the Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC).
The market capitalization of the company is $6.25 billion, with the average Volume of 3.03 million. The stock currently has its 52-week high range of $20.11 and 52-week low range of $15.69. The Price to Sales (P/S) of the company is 35.93, whereas P/B (Price to Book) stands at 0.86. Looking at the volatility of the company, weekly volatility is at 0.65% and monthly volatility is at 1.13%.
Some Red Flags
Internally, net income year to date has significantly underperformed when compared to the S&P 500 REIT Index. Specifically, the net income has decreased 206% from this exact time period last year, falling from -$252.00 million to -$772.00 million. Other negative factors affecting the company's performance is a weak return on equity, which has slightly decreased from the same quarter one year prior. Therefore, we can assume there is a weakness within the firm. An organization once at the top of the industry now falls behind. Compared to other REITs, American Capital Agency's return on equity significantly trails the industry average as well as the S&P 500. On top of the already staggering hits, net operating cash flow has decreased 18.8%, down to $362 million, all within a one-year span. The company lacks cash, and in its industry this makes it very difficult to operate successfully.
Over the past year, filled with many stock fluctuations, the direct result is that American Capital Agency's price has not changed very much. It has relatively remained stagnant, which was most likely a direct result of weak earnings growth. No matter the outcome, investors must not lose sight of the fact that the performance of the overall market, as measured by the S&P 500 Index, was essentially similar. The fact that the stock is now selling for less than others in its industry in relation to its current earnings is not reason enough to buy this stock. The many other factors mentioned back up my hypothesis that AGNC will begin to slowly fall. The revenue fell significantly faster than the industry average of 12.0%. Since the same quarter one-year prior, revenues fell by 30.1%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
As for the double-digit yields, this can potentially be a liability in a high-interest rate environment. That's because the bond markets would offer increased competition with a much higher margin of safety than common stock ownership. mREITS profit from the difference, or spread, between interest rates earned on their mortgage loans and their short-term borrowing rates. With a volatile market, the competition of bonds will have a staggering effect on the performance of mREITS. American Agency Capital is exposed to credit risk. Grants Interest Rate Observer has indicated for an expectation for an uptick in inflation, which we've already seen materializing in the United States economy. With inflation, comes a natural increase in credit risk which brings in the question about the health of AGNC's balance sheet.
In short, I am bearish AGNC. Look to see the company decline over the next year and possibly into the five-year chart. This consensus is driven by multiple weaknesses, such as unimpressive growth in net income, disappointing return on equity and weak operating cash flow, which in turn will have a greater impact than any of its strengths.
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.