New Residential Investment: Why I Am Aggressively Buying The Drop

About: New Residential Investment Corp. (NRZ)
by: Achilles Research

The shares of New Residential Investment Corp. have dropped off lately which provides value-oriented income investors with a buying opportunity.

The selloff happened on the back of growing fears over an escalating trade war and an inverted yield curve.

Fears over an inverted yield curve and a potential dividend cut are widely exaggerated since New Residential Investment Corp. actually has impressive excess distribution coverage.

NRZ is hedged against different interest rate scenarios.

Thanks to the drop, an investment in NRZ now yields 13.2 percent.

The drop in New Residential Investment Corp.'s (NRZ) share price is another promising opportunity to gobble up shares in the mortgage REIT at a lower valuation and a higher yield. New Residential Investment Corp. has one of the best distribution coverage stats in the sector and the dividend is not at risk, in my opinion. Further, New Residential Investment Corp. is hedged against different interest rate paths, which should provide downside protection. Since shares are now much cheaper than just a few weeks ago, I am buying the drop. An investment in New Residential Investment yields a whopping 13.2 percent.

Buy The Drop

Every once in a while, Mr. Market clubs down a stock or a market segment for no apparent reason. New Residential Investment Corp. was one of the biggest losers on Friday, for instance, trading down 3.88 percent on no company news. Since the end of May, New Residential Investment Corp.'s share price has dropped ~8 percent.

See for yourself.

Source: StockCharts

Is there a reason for the drop?

Not really. The stock market has been volatile in the last couple of weeks, yes, especially after trade tensions between the United States and China escalated throughout May and U.S. President Trump threatened to impose tariffs on Mexican imports in June. However, President Trump has taken the tariff threat against Mexico off the table at the end of last week, which could reverse the downtrend.

Mortgage REITs have come a bit under pressure lately as the yield curve further inverted, raising fears that their investment yields will compress going forward. Keep in mind, too, that some mortgage REITs including Annaly Capital Management, Inc. (NLY) and AGNC Investment Corp. (AGNC) pre-announced dividend cuts in April and May on the back of a flattening yield curve and lower earnings expectations.

An inverted yield curve, however, should be no threat to New Residential Investment Corp. The mortgage REIT has positioned its investment portfolio for various interest rate environments, and is actually well hedged against a decrease in interest rates, should the Fed decide to react to slowing economic growth with a rate cut.

Source: New Residential Investment Corp. Investor Presentation

Lower interest rates tend to increase mortgage prepayments as people refinance their mortgages. However, this is not a big threat to New Residential Investment Corp. since only a small portion of its mortgage portfolio, 13 percent to be exact, can be refinanced.

Source: New Residential Investment Corp.

Superb Distribution Coverage

It makes sense to remind level-headed high-yield investors in light of the emotionally-fueled selloff that New Residential Investment Corp. has one of the best, if not the best distribution coverage stats in the mortgage REIT sector, and that there was no development or event that points to a deterioration in excess dividend coverage. If anything, New Residential Investment Corp. could raise its payout since the degree of excess distribution coverage is so high (implied core earnings payout ratio of just 82 percent in the last three years).

Source: Achilles Research

Valuation And Attractive Risk/Reward

New Residential Investment Corp.’s shares are attractively valued on the drop. Income investors pay just 7.1x annualized Q1-2019 core earnings and 0.92x book value. Historically, New Residential Investment Corp.’s shares had been priced at a premium to accounting book value which makes the current drop even more appealing. The risk/reward-ratio at today’s valuation point is very attractive, in my opinion, especially when recognizing that the company covers its payout handsomely and that it didn’t report any negative news at all.

Chart Data by YCharts

Downside Risks

New Residential Investment Corp.'s shares could trade lower in case of deteriorating market sentiment, maybe based on a further escalating trade war between the two largest economies in the world, or signs of a U.S. recession. New Residential Investment Corp.'s shares are not immune to a market downturn, but the dividend should be safe, even if tariff tensions grow and the yield curve inverts further.

Your Takeaway

I have been a buyer of NRZ on the drop and think the risk/reward is exceptionally attractive right now. The selloff in New Residential Investment Corp.'s shares is totally unjustified, in my view, and level-headed income investors are now confronted with another buying opportunity for this exceptional mortgage REIT, especially now that the U.S. has taken the Mexican tariff threat off the table. Though the market still has to grapple with the U.S.-China trade conflict, Mr. Market is likely overreacting here. Further, New Residential Investment Corp. is prepared for multiple interest rate scenarios and should not be negatively affected by a potential rate cut. Speculative Buy.

Disclosure: I am/we are long NRZ, NLY, AGNC. 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.