- NexPoint Real Estate Finance continues to generate attractive and growing financial performance on the bottom line.
- The company's fundamental condition is better than it was previously and its portfolio is expanding nicely.
- For investors who are bullish, the common units are still much more appealing than the preferred.
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One interesting company for investors to consider is NexPoint Real Estate Finance (NYSE:NREF). This entity focuses on originating, structuring, and investing in a wide array of different securities. Examples include CMBS (collateralized mortgage-backed securities), interest-only strips associated with them, mezzanine financing, preferred equity financing, and more. Recent performance by the business' stock has not been horrible but it hasn't been great either. Fortunately, the financial performance of the business has been rather robust. Although the company has made at least one questionable decision, its overall strategy and the value proposition it offers are encouraging. In particular, the common stock of the company continues to stand out over the preferred units (NREF.PA). So for investors who do believe in the opportunity the company offers, opting for the common stock may be the best way to go.
Recent developments are mixed
When I last wrote about NexPoint earlier this year, I rated the company a neutral prospect. However, I did indicate that the common units were a superior avenue for investors to explore compared to the preferred units. Not only do they offer more upside potential, in the form of share price appreciation, they also provide a higher yield based on current pricing. Since the publication of that article, NexPoint has generated a negative return for investors in the amount of 3.5%. Though not great, it is not significantly worse than the paltry 1.9% return generated by the S&P 500.
Since I last wrote about NexPoint, a few things have changed. First and foremost, the company has continued to grow. Today, it has 64 investments in its portfolio totaling around $1.6 billion in value. This compares to the roughly $1.5 billion in value the company's portfolio had previously. For a company with a small market capitalization of $414.65 million, any sort of increase like this is great. In just the latest quarter, the company expanded its portfolio by acquiring five CMBS IO strips with an aggregate notional amount of $199.3 million. By comparison, they sold only three CMBS IO strips for just $3.9 million. Sequential to the first quarter, the company's book value per share increased modestly from $20.33 to $20.38.
One thing that I noticed is that the geographic concentration of the company's investments is slowly changing. When I last wrote about the firm, investments totaling 30% of its portfolio were located in the state of Georgia. Today, that number is closer to 27%. Its exposure to Florida declined from 19% to 17% while its exposure to California dropped from 5% to 4%. In Texas, meanwhile, its exposure grew from 9% to 10%. Outside of geographic considerations, there are other ways in which its portfolio has changed. Previously, 39.5% of the company's portfolio was invested in securities tied to the multifamily property market. That number has since risen to 43.3%. Meanwhile, its exposure to the single-family rental market dropped from 60.5% to 56.7%.
General financial performance for the enterprise has come in fairly strong. When I last wrote about the firm, first quarter financial results for the 2021 fiscal year had been reported. They indicated improvement over the same time a year earlier. That improvement has continued through the latest quarter, with net investment income climbing from $4.61 million to $5.29 million. Total income did drop from $21.66 million in the second quarter of 2020 to $15.87 million in the second quarter this year. However, net income ticked up from $5.27 million to $5.54 million while operating cash flow more than doubled from $6.76 million to $13.77 million. This indicates that the company's portfolio is doing well in the current environment. Already in the first half of 2021, operating cash flow stands at $22.84 million. That is not too far off from the $32.90 million the company generated in all of 2020.
To continue its expansion efforts, management is actively raising capital. As an example, since I last wrote about the firm, it issued 2.3 million shares of stock, bringing in $48.3 million in gross proceeds from the transaction. This is the one maneuver by management that I believe to be questionable in nature. Although the company does have $1.11 billion in debt, exposing it to some risk, paying that debt down may not be the best move. It is unclear if this will be what management uses the money on, since they did indicate that they may look to make investments with it. However, they specifically mentioned paying down some of the debt under its master repurchase agreements as a possible use. Debt under this category comes out to $177.63 million and has an annual interest rate of just 1.86%.
I understand why management would want to pay this debt down since it is short term in nature and rolls over every one to two months. Short maturity debt like that can come back to bite in tough times. However, on August 18th of this year, management announced that they were increasing their annual distribution by about 11.9%. Based on current pricing, this results in a yield of almost 10.9%. That compares to the 9.7% that the yield was at without factoring in the increase, and it is higher than the effective yield today on the company's preferred stock of just under 8.2%. Not only is there a big disparity between the extra stock the company issued because of the dividends the company is paying out, there's also the fact that the business does not benefit from a tax shield on distributions like they do on interest payments. This ultimately leads to additional costs, if we define cost as a cash outflow, for the company moving forward.
At this point in time, it is clear that the management team at NexPoint continues to grow the company successfully. Ultimately, my overall assessment of a neutral rating remains unchanged. The company's short operating history is one reason for that, but I also don't like the fact that management issued additional shares with the thought of paying down low-interest debt. If that money is ultimately reinvested into high-yielding investments instead, then my attitude on that will change. On the whole, I do believe that investors who are bullish about the firm would be better off playing the common stock over the preferred. Not only do they have the prospect of unlimited upside, while the preferred units are unlikely to experience that, they are also going to receive a larger cash payout on an annualized basis. Only in the event that the company stops paying distributions would I switch this opinion.
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This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
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