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Is Annaly Capital Management the Right Stock for Your Portfolio?

August 01, 2012 | About:
Annaly Capital Management (NLY) was established on Feb. 18, 1997. It was formed as a real estate investment trust (REIT). It mainly invests in agency-backed mortgage backed securities. Annaly focuses on generating income to make distributions to stockholders. Just like all other mREITs, Annaly borrows in the short-term debt market and invests in long-term mortgage-backed securities. The spread between long-term investments and short-term borrowings makes up the major portion of earnings for the trust. Another source of earnings for Annaly is the dividends received from its taxable REIT subsidiaries.

Michael A. J. Farrell, CEO of the Annaly, is known to be a shrewd manager and is often credited with the success of the trust. People believe that it was Farrell who helped Annaly come out of the 2008 credit panic unscathed, while a lot of other mREITs ceased to exist during that period. Management at Annaly Capital has devised a prudent investment strategy, which has helped the trust grow.

Stock Performance and Ratio Analysis:

The 52-week range for Annaly is $14.05 to $18.45, and the stock is currently trading next to its 52-week high. Average volume of shares traded is about 10 million shares. With a market capitalization of $16.82 billion, Annaly is selling 29 times earnings. Current EPS is $0.50, while it has a small beta of .28. There is strong institutional ownership of 42% in the stock. Being a high dividend-paying stock, Annaly is an attractive investment for institutional investors as well as many retirees. Financial results for the first quarter were better than expected. Return on assets was not that impressive at 3.15%, but ROE was quite strong at 22.98%.

Dividend Analysis:

Annaly has been paying substantial dividends since it started operating. Dividends are paid quarterly. Annaly dividends have not been steady as some of its peers exhibit. The dividends have been fluctuating in the last two years and have been readjusted downwards twice after going up in the previous quarter. The stock offers a remarkable dividend of 13.16%. On the other hand, dividend yield in the dividend-paying stocks market is 3.9% on average. The highest dividend paid by Annaly was $0.75 in the fourth quarter of year 2009. After that time, dividends have been fluctuating between $0.68 and $0.55. Hatteras Financial (HTS) and Two Harbors (TWO) have almost identical dividend yields of 12% and 14.59%, respectively. Due to the high percentage of earnings being distributed as dividends, mREITs tend to have higher dividend yields. Annaly is rated as having an excellent dividend yield, but it is not known for increasing the dividends on a consistent basis. Annaly is expected to maintain a good dividend yield and payout.

Leverage Analysis:

Annaly has a very high leverage of 7.66. The company has been increasing leverage since 2009. Annaly currently has a total debt of $86.27 billion, while long-term debt portion is $40.14 billion. Although the business model of the trust requires it to borrow and invest, this high amount of debt can be problematic if things start to go wrong. High leverage is used to magnify returns. High leverage can also backfire, and things can go terribly wrong.

Spread Analysis:

Almost all of the mREITs borrow in the short-term debt market and invest in the long-term mortgage-backed securities. Annaly mostly borrows for 30 days and invests in agency-backed mortgage securities. New borrowing is made to pay the old debt. In the current interest rate structure, when the yields are almost at the historical lowest, Annaly can manage to generate positive spread from the investments. After the announcement by the Fed that the interest rates will stay at zero through 2014, mREITs have been encouraged. Lower borrowing costs will help maintain a healthy spread. One fear for the mortgage investors is the refinancing by home owners. If the home owners start refinancing at the low rates then spreads can become narrower. Annaly Capital is expected to enjoy a healthy spread in the near future. Should the mortgage rates keep falling, it will be difficult to maintain these spreads in the long term.

Summary:

Annaly showed improvement in its recent financial results and exceeded market expectations. As long as the borrowing rates remain low, Annaly will carry on making positive spread, and it can maintain a high dividend yield. On the other hand, if the economy starts to improve and the interest rates start going up, it will be critical times for Annaly. As the Fed has announced that the interest rates will stay zero through 2014, we can expect Annaly to perform well during the coming year. Although the big amount of long-term debt remains a problem, it should not hurt the trust in the short run. I believe Annaly can give decent returns in the coming year, and it will keep paying a healthy dividend for at least two more years. I rate this stock a buy/hold.

About the author:

ogulsev
Efsinvestment.com website offers simple do-it-yourself type of investment ideas. You can download excel files that can easily calculate the Fair Value of a stock, along with O-Metrix score and Margin of Safety.

Investment philosophy is to first determine the maximum loss, and invest accordingly. Like many value investors, we prefer to invest in stocks with the highest dividend yields, and highest EPS growth potentials. Telecommunication and energy stocks in emerging markets are among the favorites.

Based on extensive quantitative analysis, in any market, going short is risky. Statistical analysis shows that technical indicators work only if they are strong enough to convince the majority of the investors. Do not buy a stock at the top, do not sell a stock at the dip.

Visit ogulsev's Website


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