The Right Price For Hatteras Financial And American Capital Agency

Mar.23.12 | About: Hatteras Financial (HTS)

Following on with a thought we had in this article the other day, the question comes up: What is the correct market price of Hatteras Financial (NYSE:HTS)?

Here is the current price and dividend yield. I am going to compare it to American Capital Agency (NASDAQ:AGNC) which everyone loves:

Price Div Yield
American Capital Agency AGNC 29.57 16.91%
Hatteras Financial Corporation HTS 27.79 12.95%
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Note: Both of these Mortgage REITs are 100% agency-backed, are big and have been around long enough to get a performance measurement. Both are trying to raise additional capital by share issuance, and both are leveraged roughly equally at around 8:1. HTS's interest rate spread is lower because it invests primarily in ARMs and 75% of its portfolio will reset in 3-8 years.

1. At Equal Dividend Yield

Based on Current Dividend Yield
HTS Div Yield 0.1295
HTS Div per Share 3.60
AGNC Div Yield 0.1691
AGNC Div per Share 5.0000
HTS Price at AGNC Div Yield 21.29
AGNC Price at HTS Div Yield 38.60
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At equal dividend yield to the more beloved AGNC the correct price of HTS should be around $21. If you do the calculation in reverse, AGNC should be closer to 39.

2. If Dividends Continue on their Current Trajectory

Here is the dividend payout for HTS and AGNC over the last few years:

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Here is a calculation using as starting point the beginning of 2010:

HTS AGNC
Current Price 27.79 29.57
Current Div Yield 12.95 16.91
Dividend, Q1 2010 1.2 1.4
Dividend, Q1 2012 0.9 1.25
Shrinkage Rate (Per Year Avg) 0.15 0.075
Expected Dividend, Q4 2012 0.75 1.175
Q4 2012 price at current yield 23.17 27.79
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If the dividends continue at this trajectory, and assuming similar yield, the logical stock price of HTS should be about $23, and the price of AGNC only a little below what it is right now, just under $28. This pretty much explains the difference. The market has priced in the shrinking dividend of AGNC to a greater extent than that of HTS.

3. At a Comparable EPS Multiple

AGNC Price 29.57
AGNC PE 5.66
AGNC EPS 5.22
HTS Price 27.79
HTS PE 7.01
HTS EPS 3.96
HTS Price at AGNC PE 22.44
AGNC Price at HTS PE 36.62
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HTS is currently trading at about 7 times earnings, versus AGNC at 5.66. If HTS were valued in the marketplace at the same level, we'd be looking at a price between $22 and $23. If you do the reverse calculation, we're looking at an AGNC price of around $37.

4. There is No Sentiment to short HTS

Here is the current percent of the float that is short for these companies. I'm not ready to say that there is much difference between the two:

AGNC Short % of Float 4.88%
HTS Short % of Float 4.77%
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Keep in mind that the world is chaotic, and there are no guarantees on anything, but I think we can conclude the following:

If HTS is correctly valued in the marketplace where it now is, AGNC is undervalued by nearly $10. Logically, if AGNC is priced correctly in the market, HTS should be in the low $20s, as we noted the other day.

The explanation may be that the market has punished AGNC to a greater extent for its recent dividend cuts than HTS. Whether this will continue to be the case is obviously the question of the day, and there is a chance for price movement in both of these funds if the market readjusts.

Do with this information what you will.

Disclosure: I am long AGNC, CYS, ARR, IVR, TWO.

Additional disclosure: My long order for ARR was finally executed, and I exited CIM yesterday in advance of the ex-dividend date, which is next week.