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Suman Chatterjee
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Financial analyst-writer for the last 3 years. Writes for a number of financial publications including The Street, Motley Fool and Seeking Alpha. Completed his Bachelors in Business Administration (Finance) with GPA 3.0, currently pursuing Chartered Accountancy from ICAI, India. Specializes in... More
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  • What I Think Of ARMOUR Residential REIT

    While the rising mortgage rates increase the chance of higher revenue, higher leverage still concerns me about Armour Residential (NYSE:ARR). It is not a people's favorite these days, as the monthly stock price graph shows. Yet you have a "buy" from my end. With increasing stability in the housing market, lower valuation and comparatively improving fundamentals, the company might be worth a glance.

    Company Profile

    This excerpt is taken from the company page:

    "ARMOUR Residential REIT, Inc. invests in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage-backed securities issued by or guaranteed by U.S. Government agencies or U.S. Government sponsored entities such as:

    • Federal National Mortgage Association (Fannie Mae);
    • Federal Home Loan Mortgage Corporation, (Freddie Mac); and
    • Government National Mortgage Administration, (Ginnie Mae).

    We are externally managed by ARMOUR Residential Management LLC."

    The main source of income (over 75%) comes from the regular mortgage payments, based on adjustable or fixed mortgage rates of interest from mortgage loan borrowers. They finance their investment in agency securities through external debt (or repurchase agreements). They qualify as a REIT, which means they incur tax-deductible incomeexpected to distribute over 90% of their income and capital gains to their shareholders.

    Market Analysis

    The most important risk that a mortgage REIT incurs is the interest rate spreads. Lower mortgage rates mean lower net income. Higher interest rates mean higher cost of borrowing debt, leading to lower net income. It is the "sweet spot" in between that is craved by REIT investors.

    The first thing to note that average mortgage rates (whether it is due 1 year, 10 years or 30 years) have already reached the bottom and it can only go up from here. Take a look at that 40 years graph below:

    (click to enlarge)

    The interesting thing is, higher mortgage rates can lead to lower mortgage applications and thus practically, lower gross income. And that should show in declining new starts, right? Apparently, new starts have been going up consistently since 2010.

    (click to enlarge)

    And although consumer confidence index went down in January as a consequence to the higher tax rates, statistics say that it has been going up since 2010. If it grows at the current rate, it should reach the consumer confidence level of 2005 very soon. With a bit of doubt on the global economy, I will say that might take a couple of years, that is, 2014.

    (click to enlarge)

    Increasing consumer confidence level, coupled with increased housing starts, indicates that the housing industry is on its path to recovery. But is it acceptable that only housing industry prospers while the other industries (and most importantly the US government) lag behind? Although the QE3 will keep the mortgage and interest rates down for some time, it will probably go up by 2015.

    To prove the effect of inflation, prices of houses have started to recover for some time now.

    (click to enlarge)

    The Fed will probably let the real estate industry growth continue for some time. With USA showing gradual growth in the natural energy and technology department, economic growth should spur in a few years and then, you can expect the mortgage rates going up then. In fact, recent news shows that mortgage rates have risen over the last week.

    Regarding the interest rate, the US treasury rates have been trading at the lowest rate since the 1960s. It peaked during the 1980s but since then, has been falling down to bottom-most levels to bring up the economic growth.

    (click to enlarge)

    With more money injected into the economy, it will go down. But most probably more money will just get shifted to the capital market and thus driving Armor's equity prices even higher. And don't worry about the stock price going higher either (Higher stock price means higher PER, right?) Higher mortgage payments on higher house prices and steady interest rates - funds flow from operations should increase for Armor Residential in the next couple of years, and that should keep the PER relatively low.

    QE3, rise in tax rates, apprehensive social welfare cuts - all these will keep the rising consumer confidence index down and thus, the interest rates down at the moment. More so, the interest rates spike will further be moderated by the "yen tsunami" by the Bank of Japan. But they will reverse once US economic growth gets stabilized, inflation grows or QE3 ends. Till then, Armor Residential's gross margin should grow.

    Competitive Analysis

    Free cash flow from operations minus one-time gains or losses on property sales (a proxy for funds for operations) has increased over the last three years. Yes this might be due to the heavy purchase of agency MBS over the last three years, which has led to an interest income of $117.7 million in 2011, compared to $447,000 in 2009. This income will grow as average portfolio inventory increases and mortgage interest rates rise over time (Note: the percentage of adjustable and hybrid adjustable securities in Armor Residential's portfolio totals down to 53.35%, with 3.9% resettable within 3 years).

    Free Funds From Operations (FFO)

    2009

    (2.6 million)

    2010

    $9 million

    2011

    $101.4 million

    Derivative trading has led to realized loss of $25 million and unrealized loss of $97 million in 2011, against realized loss of $720 and unrealized gain of $50,363 in 2009.

    Here is an excerpt from the annual FY2011 statement:

    "In addition, since we do not qualify to use cash flow hedge accounting, earnings reported in accordance with accounting principles generally accepted in the U.S. ("GAAP") will fluctuate even in situations where our derivatives are operating as intended. As a result of this mark-to-market accounting treatment, our results of operations are likely to fluctuate far more than if we were able to designate our derivative activities as cash flow hedges. Comparisons with companies that are eligible to use cash flow hedge accounting for all or part of their derivative activities may not be meaningful."

    Cash flow hedges are simply hedges, the gain or loss on which are not reported in the income statement until the forecasted transaction occurs. As the company is not qualified for hedge accounting, they use these derivative instruments on a non-designated basis and thus, the volatility in the gains and losses on the instruments are reported on the income statement. But notably, the company is hedging a lot these days. And losing market value in the derivatives might say that derivative assets are getting eroded over time, for which realized losses might increase over time.

    Having said that, total realized plus unrealized losses on derivatives were recorded at $50.4 million in Q3FY2012, compared to $74.3 million in Q3FY11 and $3.6 million in Q3FY10.

    Interest rate spread has decreased 2.05% in 2011 from 3.87% in 2009. With the recent QE3 and rising mortgage rates, the interest spread rate might improve this year. Average portfolio yield decreased to 3% in 2011, as compared to 4.59% in 2009. This is good, keeping in mind that the portfolio value might be increasing over time. In addition to that, repurchase agreements reached $5.2 billion in Q3FY12, compared to $971.7 million in Q3FY11. With a current ratio of 0.1, I am counting on increased funds flow from operations in the next few quarters to deal with that large amount of liability.

    One thing I am absolutely disappointed to see is that while the dividend per share is tanking, management and compensation fees reached around $6 million in Q3FY12.

    Now let's take a look at how Armor Residential is doing in comparison with the rest.

    Companies

    Dividend Yield (%)

    Gross Margin (NYSE:TTM) %

    Assets Turnover

    Total Debt/Equity

    Price/Tangible Book (MRQ)

    Beta

    Armor Residential

    13.6

    89.9

    0.03

    851.6

    0.89

    0.22

    American Capital Agency (AGNC)

    15.9

    74.4

    0.04

    782.2

    0.97

    1.24

    Invesco Mortgage Capital (IVR)

    12

    65.8

    0.05

    -

    1.04

    2.43

    MFA Financial (MFA)

    9

    69.9

    0.05

    347.9

    0.99

    1.09

    Disclaimer: Ratios and numbers can differ according to different sites. But when used comparatively, they should meaningfully show the financial standing of the company against that of the rest.

    Valuation - With the stock price declining over 8% in the last 6 months, Armor Residential is trading at a medium-valued level. While PE ratio is expected to fall in the next couple of years, you might want to wait a bit before putting your money in.

    Efficiency - The asset turnover ratio (a proxy for portfolio yield) of 0.03 is not much below 0.04 of American Capital and 0.05 of MFA Financial.

    Profitability - Gross margin (a proxy for net interest income margin) at 89.92% is pretty high in comparison with the rest. Perhaps the interest spread, acquired by Armor Residential, is much better than the rest.

    Leverage - With total debt/equity ratio at 851.57 and a current ratio of 0.1, the high leverage factor increases a lot of risk in terms of future cash flows. If the portfolio yield is not properly managed, this can eat into the shareholders' equity. While revenue (coupled with operating and net margin) is expected to increase, high leverage should not be a problem.

    (click to enlarge)

    Risk - Yet the low beta of 0.22 tells me that the management is taking the cautious route here. While the whole real estate industry is just recovering out of a big accident, the low beta assures me of "some" safety at least.

    Conclusion

    It might not be a good time to buy the company, but it definitely is a time to start following the regular movements of the stock. With recovering housing industry, improving fundamentals and still lower valuation, this might turn out to be a value stock in a few years.

    And as they say, you make profit when you buy, not when you sell. So stay tuned to this company.

    Source: Q3FY12 report, Google Finance, Yahoo Finance and multiple other sites.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: AGNC, IVR, MFA, TTM, ARR, reits
    Jan 31 7:26 AM | Link | Comment!
  • UPS Not So Good - With Or Without TNT

    United Parcel Service Inc. (NYSE:UPS) said Monday it will abandon a 5.2 billion euro ($7 billion) bid for smaller Dutch parcel-delivery company, TNT Express NV (OTCPK:TNTEY) after encountering unexpectedly stiff objections to the deal from the European Commission.

    The acquisition would have been the biggest in UPS's 105-year history. The European Commission, the EU's executive arm, is due to announce its decision on Feb. 5. UPS pre-empted the decision, saying after a meeting with the regulator on Friday that it expects Brussels to block the deal. Needless to say, with the news, the stock price of TNT Express has tanked by over 40% in just a day.

    UPS wanted to buy the smaller firm to challenge Europe's largest, Deutsche Post's DHL (OTCPK:DPSGY) on the European grounds, not to mention the assets in fast-growing Asia and Latin America. The collapse of the deal means a strategy rethink at UPS and as Kurt Hoefer, research analyst at portfolio manager Golub Group in San Mateo, California, says, the company does not have "any alternative but to grow it organically," which means another string of smaller acquisitions coming up soon. But the impact is far greater on TNT. Although TNT is supposed to get 200 million euros as termination fee, it is already struggling in a weak European market and lacks a strategy for developing on its own after nearly a year of negotiations on the merger. Yet this is what TNT said:

    "In a statement, TNT conceded that the 'protracted merger process has been a distraction for management' and that it would now focus on reassuring customers, encouraging employees and making money."

    With FedEx (NYSE:FDX) not showing sufficient interest in TNT, the unanimous opinion among the financial experts is aptly put below.

    "Now TNT will have to continue alone," said Philip Scholte, an analyst at Rabobank. "TNT's management will have to roll up their sleeves, come up with a plan and get down to work."

    But before we talk about any acquisition, let's look at the financial disposition of UPS and whether both the stock price and the company are in the position of further growth of value or not.

    Fundamental Analysis

    Avondale Partners recently upgraded UPS to a buy rating. Not only Avondale, but several other analysts are showering favorable (or at least, neutral) ratings on UPS. 10 equity research analysts have rated the stock with a buy rating, three have issued an overweight rating, thirteen have assigned a hold rating, and one has assigned a sell rating to the stock. The stock presently has a consensus rating of overweight and a consensus target price of $85.32. The stock is currently trading at $79.33. The book value of each share is $7.9, which means the price-to-book ratio is 10.05, far higher than Fedex's 2.12 and TNT's 0.94. Even when the street analysts are calling it a "buy" stock, this high price-to-book ratio is what makes me apprehensive about how far it can go up.

    To know the truth, we must delve deeper into the financial statements. Take a look at the graph below.

    It is clearly noticeable that the company has not reached its pre-Recession profitability yet. Although the revenue at $53.11 billion is the highest since 2003, net income margins linger at 7.16%, much lower than 9.11% in 2004. What is restraining the growth of the bottom line of the company?

    (Numbers in billions)

    (click to enlarge)

    Even the capital expenditure ratio has been steadily going down in recent years. Is the company not being able to utilize its capital properly? On a second look at FactSet data, there have been certain unusual expenses (not categorized under interest or taxes) of $424 million in FY11. And this has been continuing for four straight years since 2007. What is this expense for? It must be noted that when looking at the company statements, I don't see anything like that.

    Declining long-term investments, decreasing long-term liabilities and surging cash assets - all these mean that UPS does not know what to invest in right now. Being rejected at this TNT deal, the company comes back to square one. How will the company increase its profitability? How would the cash be invested to gain better returns in the future? Huge question mark!

    If you look at the graph below, you will see that the stockholder's equity has continuously gone down since 2007, currently at $7.11 billion, yet the net income increased with increase in sales. Now, that definitely results in a high return on equity (ROE) of 54.07%, compared to 13.55% of FedEx. That certainly seems to be inspiring at first look, but when we consider the regular share buybacks, it explains the high ROE.

    Another disturbing fact is the asset acquiring trend in the company. Check the graph below and you will understand that the company has been more focused on acquiring current assets (which includes cash by the way) in the recent years. To add to that, goodwill has been written down in FY11 statements.

    Yes, I see a drop in the long-term liabilities, which means that the company might be less liable to external creditors in the coming few years. This is good when the company's TTM levered FCF is $3.45 billion, almost half of total operating cash flow of $6.81 billion. This metric and the high total debt/equity ratio of 197.9 remind us that the company needs to shed liabilities that might be eating into the shareholder's equity as well. But without any solid long-term assets acquisition, the operating margin of 9.77% and net income margin of 6.11% might not improve over time.

    (click to enlarge)

    Technical Analysis

    Fundamental analysis tells you about long-term prospects while technical analysis tells you about short-term prospects. Take a look at the graph below.

    (click to enlarge)

    Longer upper shadows, longer bodies. This shows that the stock has a stronger accumulation pressure and that the upward price trend might last for some time.

    Higher high's in OBV and PVT lines. When there is a strong upward momentum in the OBV and PVT lines, it means that the price might continue to go up for a few days or even months.

    Higher high's and lower low's in MACD cross overs. Even this shows that the price is trending up and since this is a lagging indicator, it does confirm the price uptrend.

    RSI signal under the 60-mark. Clearly, the stock is still not overbought at the moment. And thus, the price will still go up.

    Coupled with company share buybacks, the price will definitely go up for some time.

    Conclusion

    To sum it all up, if you are a short-term investor, this is a "Buy" at the moment. With the price uptrend and positivity from the deal termination, the stock price is supposed to go up for some time (at least till the next financial report is released).

    For long-term value investors, the company does not seem to have strong fundamentals, and thus, it does not seem so alluring to me at the moment. Notwithstanding the fact that with dividend yield of 2.77% (which is still lower than 4.36% in 2008), compared to 0.57% of FedEx, the stock might be a good source of dividend income.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Jan 16 10:55 AM | Link | Comment!
  • Can You Give Some More Time To Ford?

    Is the amount $445 million really that big a loss for a company with market cap of $44.27 billion? Well, it might be if the same company saw $2.2 billion revenue loss in the second quarter this year and $1 billion in the third quarter this year, on YoY basis. Yes, that's pretty much the case with Ford Motor Company (NYSE:F).

    Today, Ford was denied $445 million in interest on overpaid corporate income taxes, from 1983 to 1989 and in 1992 and 1994, to the US government. The first lawsuit was filed in 2010, when it was rejected by a federal judge in Detroit. Ford appealed again in the US Court of Appeals in Cincinnati on the basis of IRS revenue procedure. And this was the final judgment:

    "We are unwilling to place so much weight upon an interpretive aid that binds neither IRS nor this court," U.S. Circuit Judge Julia Smith Gibbons wrote. The procedure cited "does not even enjoy the status of an agency regulation," she said.

    Ford has not yet replied anything to that, but it probably means that it might not be able to take any further actions. Needless to say, you can record the amount as "bad debt write-offs" on the US government!

    How big is that loss for Ford? Let's look at the bigger picture. How is Ford performing on the financial front? Here's a quick financial summary of the Q3FY12 results:

    (click to enlarge)

    Not to mention the declining revenue amount, the EPS of $0.41 is still meager (yet acceptable) at best, up from the $0.26 in Q2FY2012. But one thing to note, things don't look promising from the above chart. Strangely, Ford still continues to boast "strong performance" in each of its financial statements. Is there any specific reason for that?

    Let's give a look at the comparative stats:

    Company

    EPS

    Price-to-Book Ratio

    Total Debt-to-Equity

    Return On Average Assets (ROAA)

    Operating margin

    Ford Motor

    4.42

    2.89

    662.02

    11.79

    5.60

    Toyota Motor (NYSE:TM)

    5.65

    1.08

    113.79

    0.56

    1.91

    Daimler(OTCPK:DDAIF)

    6.88

    1.11

    156.89

    4.25

    7.93

    General Motors (NYSE:GM)

    2.66

    1.40

    34.97

    4.30

    3.78

    Volkswagen (OTCQX:VLKAY)

    12.54

    1.30

    162.56

    6.98

    7.07

    Honda Motor (NYSE:HMC)

    2.20

    1.16

    93.98

    1.04

    2.91

    Nissan Motor (OTCPK:NSANY)

    1.92

    1.06

    121.56

    3.46

    5.55

    Tesla Motors (NASDAQ:TSLA)

    -3.69

    16.05

    125.04

    -46.28

    -123.13

    Source: Google Finance

    Looking at the above chart, the operating margin of 5.6%, EPS of $4.42 and ROAA of 11.79% is still one of the highest in the industry. So even when the numbers on the income statement are going down, they are still better than most in the industry. And regarding the slightly high price-to-book ratio, it's really not that big compared with the other metrics. Perhaps we should put more trust in Alan R. Mulally!

    Not to forget, popular analysts' estimate say that Ford's performance can be discouraging in the coming few quarters, but things will probably turn around by the end of 2013.

    Revenue Est.

    Current Qtr.

    Next Qtr.

    Current Year

    Next Year

    12-Dec

    13-Mar

    12-Dec

    13-Dec

    Avg. Estimate

    32.99B

    31.94B

    125.00B

    130.85B

    No. of Analysts

    13

    10

    18

    18

    Low Estimate

    30.95B

    30.52B

    123.05B

    124.61B

    High Estimate

    34.03B

    33.85B

    126.13B

    134.74B

    Year Ago Sales

    32.60B

    30.52B

    128.20B

    125.00B

    Sales Growth (year/est.)

    1.20%

    4.60%

    -2.50%

    4.70%

    Source: Yahoo Finance

    Conclusion

    In the last 3 months, Ford's stock price improved by 10%, but this is not going to stall here as of yet.

    It is likely that with the improvement of sales and operating performance of Ford as expected in 2013, the PE ratio might see some boost, which just means that price might rise over time. So if you decide to buy some stocks now, you might be able to rake in some capital gains later.

    Having said that, nobody can predict the future, can they?

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: Equity investing is subject to market risks. Think twice before you act.

    Tags: GM, HMC, TM, TSLA, VLKAY, F, long-ideas
    Dec 19 9:06 AM | Link | Comment!
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