Annaly Capital Management: Back From The Ashes?

| About: Annaly Capital (NLY)
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Summary

Annaly's accounting book value discount has narrowed substantially thanks to the recent share price recovery.

Annaly is still relatively cheap on a run-rate core earnings basis.

Accretive Hatteras Financial acquisition and share buybacks add to the appeal of NLY as an income vehicle.

An investment in NLY yields ~11 percent at the time of writing.

Annaly Capital Management, Inc. (NYSE:NLY) informed shareholders in April that it was buying publicly-traded mortgage real estate investment trust Hatteras Financial Corp. (NYSE:HTS) in a transaction worth $1.5 billion consisting of both a stock and cash element. Besides being accretive to core earnings and book value (Annaly is paying ~0.85x estimated accounting book value as of the end of February for the mortgage REIT), the acquisition of Hatteras' floating rate investment portfolio made good sense for Annaly from a diversification point of view (Annaly has largely exposure to fixed rate investments).

In my piece "Annaly Capital Management: Accretive Acquisition Makes This 12% Yielder A No-Brainer", published at the beginning of the May, I speculated that the acquisition potentially significantly enhances Annaly Capital Management's dividend potential. Since the acquisition is adding to Annaly's core earnings base, the mortgage REIT might want to increase its regular cash dividend to shareholders at some point.

Besides improved dividend potential, there are two other reasons to take a good, hard look at the mortgage REIT for purposes of income investing.

1. Low Valuation Based on Run-Rate Core Earnings

Annaly Capital Management has bounced back strongly from January lows, but the mortgage REIT is still far from being overpriced. Annaly's shares have advanced ~18 percent so far this year on the back of recovering investor sentiment toward high-yield income vehicles.

The increase in share price has reduced Annaly Capital Management's accounting book value discount substantially since January, but the reward-to-risk ratio remains compelling at ~$11 IMO.

Annaly's accounting book value at the end of the March quarter was $11.61/share, down from $11.73/share at the end of December. Since Annaly sells for ~$11 at the time of writing this article, Annaly's accounting book value discount has effectively narrowed to ~5 percent.

Importantly, Annaly Capital Management remains cheap on a run-rate core earnings basis, and that's worth something: The mortgage REIT earned $0.30/share in normalized core earnings in Q1-16. Therefore, Annaly's shares change hands for ~9.2x Q1-16 normalized run-rate core earnings, which is quite an acceptable price to pay in my view.

2. Buying Back Shares

One way a company can maximize value for shareholders is by repurchasing shares when they are selling for a discount in the market. Total no-brainer.

Fortunately, the mortgage real estate investment trust is doing that. Annaly Capital Management spent $217 million since November on its own shares, $103 million during the first quarter, and it is likely that the mortgage REIT will continue to repurchase shares throughout the remainder of 2016.

Your Takeaway

Annaly Capital Management's shares have surged a whopping ~18 percent this year, which is remarkable considering how poorly stocks did at the beginning of the year. Annaly's Capital Management's announcement to acquire mortgage REIT Hatteras Financial has without a doubt helped shift investor sentiment to the positive.

Annaly Capital Management's shares are still fairly cheap IMO, selling for ~9.2x normalized run-rate Q1-16 core earnings, which is NOT expensive for a stock that comes with an eleven percent dividend yield. Buy for income and capital appreciation.

Disclosure: I am/we are long NLY.

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.