12% Yield Acquired: Why I Bought Annaly Capital Management

| About: Annaly Capital (NLY)

Summary

One of the most common failures in the sector is for prices to swing with reported dividend yields.

Annaly Capital Management had a terrible price performance in the third quarter, but should have great book value gains.

I see multiple potential catalysts for sending the shares higher and expect them to be one of the top performers in Q4 2016.

Following my own research, I bought shares in Annaly Capital Management.

The most predictable failure for mortgage REITs is their tendency to trade on dividend yields. Annaly Capital Management (NYSE:NLY) has delivered the worst performance among the mortgage rates since the start of the 3rd quarter. However, I don't believe they delivered weak performance on book value. The only metric that Annaly Capital Management really struggled with was share price. Their share price declined materially over the quarter, and their discount to trailing book value increased substantially. No other mortgage REITs discount to trailing book value grew as rapidly as Annaly Capital Management. This all brings us back to a couple of issues. The first is that Annaly Capital Management was simply too expensive on June 30th 2016. That issue has been corrected.

Acquisition

The other issue is the Annaly Capital Management acquired another company. In connection with the acquisition, they paid a partial quarter dividend. That dividend has been treated poorly by virtually every financial tool I can use to assess it.

What is the yield on their stock?

The funny thing is many investors reading this may believe that the stock is currently yielding around 10.45%. That is blatantly wrong. The yield on the stock is only a hair shy of 12%. The trailing "annualized dividend" shows up as $1.06 in several screening tools. The actual trailing dividend annualized is $1.20. This all comes back to that one partial quarter dividend. This is an example of the market failing. Perhaps even more remarkable, I called out that this might happen earlier in the summer.

So how many tools are wrong? I haven't looked through them all, but Yahoo Finance was used by many retail investors. Since several of their tools are very easy to use, they also get used by some public analysts. However it is not just Yahoo Finance that is wrong. I checked the research screens through two different brokerages. Both were wrong. I believe that being wrong on this metric is significantly more common than being right. Because the mortgage REITs tend to move up or down in share price along with their dividend, the appearance of a dividend cut is enough to push prices lower.

Which mortgage REIT is most likely to "raise" dividends in the fourth quarter?

The answer should be Annaly Capital Management, but not because they would actually raise the dividend. Actually raising the dividend is not necessary for an adjustment in relative share prices. Since several of the tools for evaluating mortgage REITs are using incorrect dividend information, the correct dividend information released for the next quarter could correct several of those tools.

To be clear, I am not suggesting that the quarterly dividend will be higher than $0.30. My best projection for the fourth quarter dividend is $0.30. I would be surprised if there was any change. However, I would also be surprised if the tools for tracking dividend yield did not find themselves adjusted after the announcement.

Potential Catalysts

T here are a few catalysts I see for bringing Annaly Capital Management back to its place as one of the premier mortgage REITs. The first is that the earnings release will be coming up soon and management will be providing new information on their book value from the end of the 3rd quarter. I will believe that book value has increased even without adjusting for their acquisition. Because the acquisition was made at less than book value, I believe the acquisition will add a little book value on top of the gains that came from the net changes in LIBOR and mortgage bond pricing.

It is worth pointing out that as an analyst there is a lack of data on the combined portfolio. Positions may have been closed to adjust the combined portfolio. Consequently, it is possible that my model (and many others) would be less accurate.

The next catalyst is commentary from management. The new CEO of the company, if I can still refer to him as new, has been exceptionally talented at handling earnings calls. I expect that trend to continue. If he starts talking about the environment for mortgage REITs, it may make investors a little more enthusiastic. Another catalyst is the previously mentioned Q4 dividend announcement. That announcement probably won't occur until late in the quarter. Either the announcement or the anticipation of the announcement should push the stock higher. Of course the timing is questionable.

It is also possible that Annaly Capital Management would be able to encourage the various financial institutions to correct their records and adjust the yield on the stock. That might be one fast way to correct the issue. However, that seems like significantly more work than simply making the fourth-quarter dividend announcement early. By simply announcing the dividend earlier, Annaly Capital Management could correct the tools that are providing investors with inaccurate information.

Due to the expectation for this error to be corrected and the belief that book value will include a respectable gain, I believe Annaly Capital Management is likely to deliver one of the strongest performances over the next two months in their "discount to book value".

Rating

I am reiterating a buy rating on the stock. To go with my buy rating, I purchased a large position in Annaly Capital Management. This is one of the mortgage REITs I want to I'm going into earnings season.

I am also long on NLY-D. I recently captured the gains on NLY-E to fund new acquisitions, including my buy of the common stock in NLY. Preferred shares were on a strong rally last week. If those strong prices continue, I may close some of those positions to take lower priced securities with strong fundamentals.

Disclosure: I am/we are long NLY, NLY-D.

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. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. 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.