Annaly Capital Management, Inc. (NLY) is the bellwether of REITs. With a double-digit dividend, it has attracted the interest of investors for the last couple years. I believe the company will continue to perform well for a REIT, but I also believe that there are some signs that it is possible the best years are behind the company. Profit levels may be tightening, and for a REIT, this also means dividend levels may be about to turn around too.
Why are Analysts downgrading the Stock to Sell?
FBR Capital lowered its outlook on Annaly Capital Management from a market perform rating to an underperform rating with a price target of $16.00. The stock is presently trading at 16.89, so FBR Capital is expecting the stock to fall. What is it's reasoning? FBR Capital believes that because of its size, Annaly has a higher than average exposure to mortgage loan prepayments. With the state of the mortgage environment, it also believes Annaly's dividend will continue to shrink. The REIT has reduced its dividend over the past year and more cuts are seen in its future. Wells Fargo downgraded the company a couple weeks ago from perform to underperform.
Nomura Securities in neutral on Annaly, but also has a lower price target of $16.50. Like FBR Capital, Nomura does not believe the rack dividend is sustainable anymore. Spread income alone will not sustain the dividend without greater realized gains. Even though in 2Q2012, Annaly posted an EPS of $0.55, beating forecasts by $0.3, $0.10 of the company's EPS is related to one-time gains from the sale of securities. The EPS was stable this quarter, but the levels cannot be sustained on "one-time sales."
REITs are finding it harder to keep profit levels so good. They have reaped benefits from the low short-term rate environment, and their yields and dividends have been a nice refreshing breeze in a hard investing environment. But changes appear to be in the air for the REITs. Performance over the last year has not been as good.
REITs make money by borrowing at low short-term rates and buying assets with higher long-term rates. They have done well, but as the Fed takes action, it is straightening out that curve. Short-term rates remain low, but long-term rates are also inching down, putting huge pressure on the profit margins of companies like Annaly. Not only are short and long interest rates moving in closer together, but mortgage borrowers are also refinancing at the lower rates that are bad for REITs because it tightens profit margins again. Higher margin rates are being moved away from these companies. This is the concern FBR Capital expressed while lowering its rating and price target.
I believe the company has superior management and will continue to perform well. Even with a shrinking dividend, it wins recognition. Dividend Channel, in its DividendRank Report, noted that NLY is the top REIT because of its attractive valuation and strong profitability:
- NLY share price of $16.89 represents a price-to-book ratio of 1.0 and an annual dividend yield of 13.16%
- The average stock in Dividend Channel's coverage universe yields 3.9% and trades at a price-to-book ratio of 1.8.
REITs are and will continue to be a popular choice for income (dividend) investors. They must distribute at least 90% of their taxable income each year to shareholders as dividends. In years of larger profits, huge dividends are paid out, and in leaner years, the portions are smaller. It really looks like the best times are behind these companies and they have just turned the corner from peaking. Analysts are no longer favoring these stocks. I believe Annaly will still offer a higher-than-average dividend for a while, but I also believe that this will continue to shrink.