By Vinita Basu
Companies in the sector of Real Estate Investment Trusts (REITs) in the U.S. have suddenly come into prominence thanks to the gradual recovery of the U.S. economy. With the fall in the number of jobless claims and a continued low interest rate regime, the real estate business is picking up at a rapid pace. After all, land is a "depletable" resource in accordance with modern economic theories and therefore its value can only follow an upward graph. Hence, this industry is likely to witness unprecedented growth during the coming years. Among the companies within this industry, Annaly Capital Management (NLY) is an attractive investment option due to its low valuations and promising business model.
Annaly has a portfolio of real estate related investments, including various types of mortgages, debentures, securities and other financial services. In line with its investment policy, about 75% of assets are short-term in nature and mortgage-backed securities and the remaining is comprised of qualified REIT real estate assets. Thus the company operates in that sector of the economy which got hit the hardest in the great depression of 2008. However, despite all these uncertainties, it continued to maintain its profitability. Its common stock also showed great resilience by its stability garnering an extremely low beta of 0.22.
Being one of the largest companies in this sector , this company has a total market capitalization of about $15.35 billion. It currently operates at a whooping operating margin of about 68%, which denotes its comfortable cash flow of $2.42 billion apart from a high profitability accrued from its business. Though its trailing twelve months EPS is a paltry $0.37 with a high P/E ratio of 42.76, going by the current performance and profitability, the forward P/E (FYE Dec. 31, 2013) is expected to be a mere 7.72 and its EPS is likely to be about $2.5. This aligns extremely well for the company especially since U.S. new home sales and employment data are improving every week. The improvement in the economy along with the recovery of other financial institutions and low interest rates are in favor of the company's business.
Currently the stock holds great value due to its primary business of mortgage bagged securities which mainly concentrates on investments in government backed entities like Federal National Mortgage Association or Fannie Mae (FNMA). This reduces its business risks substantially even though its primary exposure is in the beaten down financial sector. Further, the real estate markets in the U.S. have bounced back and high-end properties are now highly sought by both national and international buyers.
Some of the comparable stocks in this segment are Simon Property Group (SPG) and Equity Residential (EQR). Both companies are ranked high in accordance with their sales in the industry.
Simon Property Group has a huge market capitalization at $43.38 billion as compared to Annaly's $15 billion. When comparing their dividend yields, the company also has an annual dividend yield of 2.68% as compared to about 14% of Annaly. Though many analysts do not consider dividend yield as measure of returns from a stock, history has proved that higher dividend yield stocks have generally given better proceeds for investors than lower or nil dividend yield stocks.
Further, the stock price of Simon Property Group, having a beta of 1.35, has also shown higher volatility and has oscillated between $99 and $147 in the past 52 weeks. Currently, the stock is trading near its 52-week high and has a high P/E of 42.13, making it unsuitable for investment at current levels. Therefore Simon Property Group, in my opinion, is not recommended for low to medium risk investors. Only high risk investors, in my view, can purchase this stock at lower levels for gains during event based announcement.
Equity Residential, on the other hand, is another giant in this sector, having a total market cap of $18.43 billion. This stock, having a beta of about 1.17, is comparatively more stable than Simon Property Group but not as much as Annaly. This stock is also trading near its 52-week high but is at an acceptable P/E ratio for the industry. However, it has a very low dividend yield of 2.20% as compared to the double digit yield of Annaly. Further, the profit margin of the company is only about 20% in its last two quarters of 2011. In comparison, the profit margin of Annaly is in excess of 68%. This has resulted in a much better cash flow for Annaly as compared to Equity Residential which is sure to make the former a higher profit generating company in this industry. Hence, in my view, even though Equity Residential boasts of a large business with a reasonable P/E of about 20, it may not be prudent for the investors to place their money in these difficult times on a company with low profit margins at current levels.
Hence, Annaly looks to be a runaway winner in the industry which not only promises good dividend yield but also high growth within its business. The fact that the company has displayed wisdom in buying government sponsored entities only and not the private ones and shown adeptness while handling investments in its past transactions makes it more attractive for an investor.
Further, even though most of the indices in the U.S. market have gone up by about 20%, this particular company has lagged behind. This implies that the stock is trading at extremely low valuations currently. Finally, its higher dividend yield, though suspected by many as higher risk, coupled by high profit margins, make it an ideal investment option in my opinion for both medium and long term investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
