Annaly Capital: Let's Face Reality Here

| About: Annaly Capital (NLY)

Summary

The stock has mostly traded sideways in recent quarters, and for an income name, this is a good thing.

I discuss recent performance of the name relative to dividend security.

A walkthrough of the math shows why you buy a name like Annaly versus a popular growth stock.

I have been holding Annaly Capital (NYSE:NLY) for years. I have analyzed the name from many different angles over the years, but at the end of the day this is an income name, plain and simple. As an income play, one of the strong positives in this name is that the stock has mostly traded sideways in recent quarters. What this means is that you are relying on the dividend payout, and that is the crux of today's piece.

While there is pressure to constantly follow the ups and downs in your holdings day to day, I contend that investors should take a longer-term approach. Higher rates bode well for the mREITs, but in the short term, rate movements could introduce volatility. Stay the course, and don't worry about the day to day. From a longer-term perspective, what we need to be concerned with are total returns and dividend coverage.

First, we should discuss dividend coverage. As we saw in the recently reported Q4 earnings, Annaly's performance was better than I expected, and it was a bit above analyst estimates. Annaly's core earnings, excluding any premium amortization adjustments, came in at $0.30 per share. What is important to note is that this is perfect coverage of the $0.30 dividend. As I have said before, for the dividends to be secure moving forward, we need this core income to rise. Given that core earnings remain close to the dividend I will reiterate that I still have some concerns, despite the dividend being maintained the last two years. However, I still see the dividend as being maintained until there are consecutive quarters of failed coverage.

What we need to watch moving ahead are the key metrics that I constantly harp on in this sector. The spread is a key indicator. In Q4 the yield on interest-earning assets rose sharply to 3.81%, and the average cost of interest-bearing liabilities, including interest expense on interest rate swaps used to hedge cost of funds, was 1.53%, which resulted in a net interest spread widening significantly to 2.28%, up from 1.13% last quarter. This is the widest I have seen the spread in many quarters. In the last two quarters, we saw the constant prepayment spike up to 15.9% in Q3 from 12.7% in Q2 2016. But in Q4, the constant prepayment rate decreased slightly to 15.6%. It is still high and something we need to watch.

Now, I cover the performance of the name because for any high dividend paying stock, we need to ensure the payout is secure. What crushes these types of stocks are dividend cuts. So long as the dividend is maintained, the name can trade sideways indefinitely for all I care. Let me be perfectly clear, we buy a name like Annaly because of the power of the dividend. Did you forget? Table 1 demonstrates the dividend history of this name since the turn of the century. As you can see, the dividend amounts are impressive.

Table 1. Annaly Capital's Dividend History Since The Start Of The 21st Century And Four Hypothetical, Single Buy And Hold Investors

Ex-Dividend Date

Dividend Paid Date

Dividend Amount ($)

Total Paid ($)

Buy Point

Share Price

12/29/1999

1/28/2000

0.35

0.35

Buyer 1- 12/13/99

$8.56

4/3/2000

5/29/2000

0.35

0.70

6/29/2000

7/28/2000

0.30

1.00

10/5/2000

10/30/2000

0.25

1.25

12/27/2000

1/29/2001

0.25

1.50

4/3/2001

5/29/2001

0.30

1.80

7/2/2001

7/30/2001

0.40

2.20

10/3/2001

11/29/2001

0.45

2.65

12/27/2001

1/29/2002

0.60

3.25

4/3/2002

5/29/2002

0.63

3.88

7/1/2002

7/29/2002

0.68

4.56

10/1/2002

10/29/2002

0.68

5.24

12/27/2002

1/29/2003

0.68

5.92

3/27/2003

4/30/2003

0.60

6.52

6/30/2003

7/31/2003

0.60

7.12

10/1/2003

10/29/2003

0.28

7.40

12/24/2003

1/28/2004

0.47

7.87

3/29/2004

4/28/2004

0.50

8.37

6/30/2004

7/28/2004

0.48

8.85

9/28/2004

10/27/2004

0.50

9.35

12/29/2004

1/27/2005

0.50

9.85

3/30/2005

4/27/2005

0.45

10.30

6/28/2005

7/28/2005

0.36

10.66

9/26/2005

10/27/2005

0.13

10.79

Buyer 2-9/18/2005

$12.75

12/28/2005

1/27/2006

0.10

10.89

3/29/2006

4/27/2006

0.11

11.00

6/28/2006

7/27/2006

0.13

11.13

9/27/2006

10/27/2006

0.14

11.27

12/27/2006

1/26/2007

0.19

11.46

3/29/2007

4/26/2007

0.20

11.66

6/28/2007

7/27/2007

0.24

11.90

9/27/2007

10/29/2007

0.26

12.16

12/27/2007

1/28/2008

0.34

12.50

3/26/2008

4/29/2008

0.48

12.98

6/25/2008

7/29/2008

0.55

13.53

9/16/2008

10/29/2008

0.55

14.08

12/26/2008

1/29/2009

0.50

14.58

3/26/2009

4/29/2009

0.50

15.08

6/25/2009

7/29/2009

0.60

15.68

9/29/2009

10/29/2009

0.69

16.37

12/24/2009

1/28/2010

0.75

17.12

3/30/2010

4/28/2010

0.65

17.77

6/25/2010

7/29/2010

0.68

18.45

9/30/2010

10/28/2010

0.68

19.13

12/23/2010

1/27/2011

0.64

19.77

3/29/2011

4/27/2011

0.62

20.39

6/28/2011

7/28/2011

0.65

21.04

9/28/2011

10/27/2011

0.60

21.64

12/27/2011

1/26/2012

0.57

22.21

3/28/2012

4/26/2012

0.55

22.76

Buyer 3-3/16/2012

$15.95

6/27/2012

7/26/2012

0.55

23.31

9/27/2012

10/29/2012

0.50

23.81

12/26/2012

1/29/2013

0.45

24.26

3/27/2013

4/29/2013

0.45

24.71

6/27/2013

7/29/2013

0.40

25.11

9/27/2013

10/31/2013

0.35

25.46

12/27/2013

1/31/2014

0.30

25.76

3/28/2014

4/30/2014

0.30

26.06

6/27/2014

7/31/2014

0.30

26.36

9/29/2014

10/31/2014

0.30

26.66

12/29/2014

1/29/2015

0.30

26.96

3/37/2015

4/30/2015

0.30

27.26

6/26/2015

7/31/2015

0.30

27.56

Buyer 4 6/17/2015

$9.85

9/28/2015

10/30/2015

0.30

27.86

12/29/2015

1/29/2016

0.30

28.16

3/29/2016

4/29/2016

0.30

28.46

9/28/2016*

10/31/2016

0.30

28.76

12/28/2016

1/31/2017

0.30

29.06

*Dividends paid consisted of $0.0358 from acquisition of Hatteras Financial and $0.2641 common dividend

Source: NASDAQ: Annaly Capital's Historical Dividend Payments

You may recall that I have demonstrated this type of exercise in the past and on other names. But it is important to see where you stand and to remind you what kind of stock this is and why we buy it. Unless there are very recent buyers, there is no way anyone is losing money in the name unless they are trading poorly or not buying on big dips. It just doesn't add up. Sure, you may have small returns if you bought at the all-time highs and simply held, but the fact is that Annaly has had an amazing history of dividends and that's why we want to own the name longer-term. The dividend has been at $0.30 for a significant amount of time and remains at the lowest it has been since late 2007 when the dividend was $0.26. Despite being down, the dividend creates long-term protective power. As I have done in other exercises, let's look at how four single time, buy and hold investors in table 1 would be doing.

Assume "buyer 1" bought at $8.56 in December 1999 and did not add on dips, sell a little when the stock ran up, or reinvested any dividends. This is simply the wrong way to invest but simplifies the math for our purposes. As of the current share price of $11.06, this person would be up $2.50 or 29%. That is a decent gain but is of course weak over nearly a 17-year period. This is where the power of the dividend comes into play. The dividends paid to date total $29.06. Assuming again they only bought shares once in December of 1999 and didn't reinvest the dividends, the investment is now up $2.50 in capital gains and $29.06 in dividends for a total return of $31.56. That is a total of 369%. A more than quadrupling of one's money is a successful investment in this time frame.

Of course, I highly doubt any of you are buyer 1. I could be wrong. Perhaps our second buyer is more like one or two of you reading who made your first buys over a decade ago. Let us assume buyer two purchased shares at $12.75 in September 2005 and, of course, only purchased shares just once. At the current share price of $11.06, this person would be down $1.69 or 13%. That is terrible considering we have doubled and then some in that amount of time in the market. But this again is where the power of the dividend comes into play. The dividends paid to date for this investor total $18.40. So, the investment is now down $1.69 in unrealized capital losses, but up $18.40 in dividends for a total return of $16.71. That is a total of 131%. A more than doubling of one's money is a strong investment return in this time frame.

Our third and fourth buyers likely represent many of you reading this column. Let us assume buyer 3 purchased shares just one time at $15.95 in March 2012. As of the current share price of $11.06, this person would be down $4.89 or 31%. This may be the case for some of you on paper who have been with Seeking Alpha or Annaly since I first started covering the name. But the dividends do matter and they total $6.85 for this investor, thus this investor is up $1.96 or 12.3%. That of course is not strong considering the general market movement, but as you can see all of those unrealized capital losses have been recouped thanks to the dividend. That said, our fourth buyer may represent many of you. This a someone who bought a year and a half ago, at $9.85. This investor is up $1.21 in capital gains on paper and of course up another $1.80 in dividends for a total return of $3.01 or 30%. This type of return rivals that of many growth stocks in the same time frame.

So what does all of this mean? It means that timing matters, and so does the dividend. Did you forget why you bought the name? Of course this does not mean you should chase yield. This is why it is critical to stay on top of the performance of any high dividend paying stock. They are not all created equal. You should never be in a rush to pull the trigger on an income name. Wait for the big pullback, and ensure the dividends are reasonably covered. Unlike any of these pretend buyers, you should be adding on big dips, and consider trimming the position when shares spike.

The big criticism? Many will say growth names have crushed the returns of Annaly. They are correct. But Annaly has something these growth names don't. Keep in mind just how strong the dividend really is. As of July 2004 for buyer 1, every single dividend paid to this investor has been in excess of his original investment. The same holds true for buyer 2 as of July 2012. These investors can't lose, even if shares approached zero. The dividends will continue to be paid out indefinitely (barring absolute catastrophe). The same cannot be said for growth stocks.

The takehome here? This is a long-term investment. This is not a trader's stock or a get-rich-quickly stock. It is a name that we are in for the dividend, and when making a purchase, you need a long-term horizon for this name. So long as the dividend is covered, the math clearly shows that eventually total dividends paid will cover your entire initial investment. From that point forward, every dividend paid is profit.

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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.

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