On Tuesday, September 25, analysts at Macquarie downgraded shares of Capstead Mortgage Corp. (CMO). The firm lowered its rating on the stock from an Outperform to a Neutral and set a price target of $14.50/share. As a result of the downgrade, shares of CMO reacted quite flat, trading down just 0.62% on Tuesday. That said I wanted to examine the company a bit further and take a look at how it compares to some of the other Macquarie downgrades with regard to mREIT sector. Most recently Macquarie downgraded both Annaly Capital Management (NLY) and American Capital Agency (AGNC), which has led to the theory that Macquarie is "no longer a fan of the sector."
Overview: Capstead Mortgage Corp.
"Capstead Mortgage Corporation operates as a self-managed real estate investment trust. It invests in leveraged portfolio of residential mortgage pass-through securities consisting of adjustable-rate mortgage securities issued and guaranteed by government-sponsored enterprises or by an agency of the federal government. The company qualifies as a real estate investment trust for federal income tax purposes. It generally would not be subject to federal corporate income taxes if it distributes at least 90% of its taxable income to its stockholders. The company was founded in 1985 and is headquartered in Dallas, Texas. (Yahoo! Finance)."
Profit Margin Comparisons
The mREIT sector has some of the highest profit margins the securities markets have to offer, and it should be noted that the three companies featured all have demonstrated very high profit margins in the last 12 months. Capstead Mortgage has demonstrated a profit margin of 91.53%, American Capital Agency has demonstrated a profit margin of 87.94%, and Annaly Capital has demonstrated a profit margin of 50.98%. It is clear from this calculation that Capstead clearly outpaces both Annaly Capital (by a ratio of 1.80 to 1) and American Capital Agency (by a ratio of 1.04 to 1) in terms of profit margin.
Operating Margin Comparisons
The mREIT sector also has some of the highest operating margins the securities markets have to offer, and it should be noted that the three companies featured all have demonstrated very high operating margins in the last 12 months. Capstead Mortgage has demonstrated an operating margin of 91.14%, American Capital Agency has demonstrated an operating margin of 88.48%, and Annaly Capital has demonstrated an operating margin of 60.25%. It is clear from this calculation that Capstead clearly outpaces both Annaly Capital (by a ratio of 1.51 to 1) and American Capital Agency (by a ratio of 1.03 to 1) in terms of operating margin.
The key catalyst for the continued sustainability of each of these company's profit and operating margins will be the level at which interest rates be held over the next 12-24 months. It has been noted that the Federal Reserve may not act on rates for some time especially after the latest round of Quantitative Easing, but I think that even if rates are increased slightly these levels can be sustained. If rates are increased by any more than 0.25%, it could be pretty disastrous for the REIT sector and more specifically the mREIT sector.
Should potential investors consider the chance to establish a position in Capstead Mortgage, Annaly Capital, or American Capital Agency, especially in the wake of their respected downgrades at Macquarie? From a comparative standpoint I think American Capital Agency is the clear winner of the group, not only because of the company's stellar profit and operating margins, but because I think even if conditions slightly worsen in terms of interest rates AGNC will be able to sustain its $5.00/share annual dividend. Capstead Mortgage, in my opinion, runs a very close second since the company is well diversified in terms of its portfolio. Unlike both AGNC and NLY, a majority of Capstead's portfolio consists of variable-rate mortgages and mortgage products. This diversification, if properly managed, has the ability to off-set risk whereas the portfolios of both AGNC and NLY are unable to do that considering each company's portfolio is not as heavily diversified in terms of variable-rate products. Lastly, I'd continue to avoid Annaly Capital Management and counterpart Chimera Investment Corp. (CIM) because I don't think either company's dividend is sustainable at current levels. As was the case last week when NLY cut its dividend for the second time in the last 12 months, I strongly believe Chimera may be headed down the same road due largely in part to the similarities both company's management and portfolio management teams have implemented in the last 12-24 months.
Potential investors looking to establish a position within the REIT sector should consider moderate positions in both AGNC and CMO and try to avoid both NLY and CIM at current levels.