Newcastle Investment: A REIT That Can't Be Beat

Jun.17.12 | About: Newcastle Investment (NCT)

Anytime that I come across a stock that virtually has the same number for trailing P/E and EPS it gets my attention. That is what we have here with Newcastle Investment Corp. (NYSE:NCT). For the record its trailing P/E is 2.72 while EPS is 2.35. Understandably there is still tremendous fear and loathing in the markets, and in particular the real estate sector, however, this is an end of the world valuation. Last I looked houses still had people living in them and buildings were home to companies.

Not only is this valuation cheap but the dividend is currently $0.80 a share for a whopping 12.2% yield. Money in your bank account is earning less than 1%, a 3-year CD might get you 2% if you're lucky and your money is prisoner for 3 years. Heck, the U.S. 10-year Treasury bond is only yielding 1.66%. I know you're thinking that this is too good to be true, that this dividend cannot be safe. I think that it is safe. Newcastle in the last 2 years has gone from suspending its dividend while it battled through and emerged from the depths of the crisis, to paying the current rate of $0.80 a share. Plus it is anticipated the next dividend stop could be $1.00 in the 4th quarter of this year or the 1st quarter of next year. Tangible book value per share is $2.60. Now the price is about 2.5 times that of book value per share, but considering that the tangible book value per share last quarter was $1.55, growth of 67.7% in one quarter, one can believe Newcastle is growing and recovering in the right way.

Below we have a residual earnings model, the Graham number, and a dividend discount model. If you follow the earnings model you might say the stock is ahead of itself based on earnings projections.

Dividends $0.80 $1.00 $1.20 $1.30 $1.40
Earnings Growth 9.77% 10.27% 12.42% 11.60%
Book Value/per share $2.60 $3.13 $3.59 $4.00 $4.51 $5.13
ROCE 51.14% 46.63% 44.84% 45.24% 44.78%
CAPM (discount rate) 33.40% 33.40% 33.40% 33.40% 33.40%
Residual Earnings $0.46 $0.41 $0.41 $0.47 $0.51
P/B Ratio 2.52 2.10 1.83 1.64 1.45 1.28
Book Value/per share (previous year) $2.60 Book Value/per share (previous year) $2.60 CAPM
PV Residual Earnings (current year) $0.35 PV Residual Earnings (current year) $0.35 Risk-Free Rate/WACC 0.2500%
PV Residual Earnings (current year + 1) $0.10 PV Residual Earnings (current year + 1) $0.10 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $0.03 PV Residual Earnings (current year + 2) $0.03 Market-Risk Premium 9.75%
PV Residual Earnings (current year + 3) $0.02 3 Year Traget Price $3.07 Beta 3.4
PV Residual Earnings (current year + 4) $0.01 CAPM 33.40%
5 Year Target Price $3.10
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The Graham number suggests that there is some upside to be had.

The Graham Number
Constant 22.5
Diluted EPS of previous year 1.07
BVPS $2.60
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The dividend model shows that this could be a possible home run and considering that this is a REIT it would be a very viable model in this instance.

2011 2012 2013 2014 2015 2016
Dividends $0.80 $1.00 $1.20 $1.30 $1.40
Required Rate of Return 33.40% 33.40% 33.40% 33.40% 33.40%
Dividend Growth 25.00% 20.00% 8.33% 7.69%
Present Value $2.40 $2.99 $3.59 $3.89 $4.19
Price Target $17.07
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If the multiple expands for its current beaten down status to a conservative 8 then the stock should be $18.80, if it expands to the industry average of 15 then we get a stock price of $35.25!

Earnings estimates (and thus dividend estimates) could also be too low due to the vast amounts of mortgage servicing rights (MSR) being acquired by Newcastle, and its partner Nationstar (NYSE:NSM). There is about $10 trillion of mortgages in the U.S so fees on servicing those mortgages can easily be in the billions. To pay for the MSR deals Newcastle has sold stock. Each offering, however, has only been between a 4-7% discount to the current stock price. Each offering has sold out showing strong institutional interest in Newcastle and has also been a good buying opportunity in general. Plus each MSR deal is expected to return 20% to the company. I don't think us value and dividend investors would mind waiting with Newcastle.

Disclosure: I am long NCT.