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Will American Capital Win The REIT Race In 2012?
Posted by: Dividend King (IP Logged)
Date: April 22, 2012 02:56PM

Real estate investment trust (REIT) returns were strong for the first quarter of 2012 reporting a 10.4% return, which was slightly lower than the overall stock market gain. The catalyst for this strong quarter was the increase in investor confidence as the broader economy continues to expand. An expansion is the economy should boost demand for real estate, including hotel and industrial space as vacation and business travel strengthens. Let’s analyze in depth how American Capital may perform for the remaining three quarters of 2012.

American Capital Agency (AGNC) earns revenue primarily through mortgage backed securities. The stock pays an annual dividend of $5, has a yield of 16.70%, and a payout ratio of 112%. During the last twelve months sales and income increased 338 and 167%, respectively. After looking at the income statement, I see the company had stellar revenue increase over the last four years – A CAGR (compound annual growth rate) of 112% to be precise. Net income increased at a CAGR of 116% during the same time period. Revenue for competitors Annaly (NLY) has increased at a CAGR of 4, while Anworth Mortgage (ANH) had a revenue CAGR decrease of 6% over the previous four years. For fiscal year 2011, the stock yielded a profit margin of 69% while Annaly and Anworth had profit margins of 10 and 55%, respectively. Furthermore, last year’s return on assets came higher for American Capital at 2.13% compared to 0.36 for Annaly and 1.48% for Anworth. American Capital does look attractive with an excellent growth in income and high profit margins, thus I expect this solid trend will remain, or even improve with the help of a better economy.

Most recently, American Capital has reached an all time high of just above $31. In fact, it is currently trading very close to this level, indicating the strong bullish momentum prevails. Thus, I think the stock is performing quite well considering it’s one of the newest REITs in the market (IPO was in mid 2008). Other fairly new mREITs are CYS Investments (CYS) and ARMOUR Residential REIT (ARR). There isn’t much historical data for CYS since it had its IPO in 2009. Nevertheless, the stock is profitable with an attractive yield of 15.05%. One drawback is that analysts are not paying much attention to this stock, at least not yet, primarily because it’s fairly new in the REIT industry and analysts choose to make estimates for other top players or more established stock. ARMOUR is a different bird, primarily because of its conspicuous investment strategy, which consists of hybrid adjustable rate, adjustable rate and fixed rate residential MBS. Another distinctive characteristic is that the stock is not yet profitable, unlike the other competitors previously mentioned. However, it still manages to distribute a modicum dividend with a high yield of almost 18%, which does not entice me personally.

Back to American Capital, the stock has a receivable turnover of 2.60; in simple parlance, that means management is collecting receivables about every 140 days. Annaly and Anworth collect their receivables every 48 and 45 days, respectively making American Capital’s management look highly inefficient at collecting its cash from consumers. The collection receivable of 140 days is too high by any standards because it indicates a debt collections problem. Conversely, if this receivable inefficiency was improved, management could deploy the cash to higher impact activities such as paying off debt, increasing dividend distributions, increasing its cash cushion, or reinvesting it.

Despite trading at a lower price to earnings ratio of 6, compared to 42 for competitor Annaly Captial and 7 for Anworth, American Capital has a more attractive return on equity of about 20% compared to about 3% for Annaly and 13% for Anworth. The reason Annaly is trading at a higher price to earnings than all of its competitors is because investors are placing a bet on the CEO’s stellar track record successful running companies. Although Annaly’s financials may be weaker than American Capital’s, many investors are willing to pay a premium for Annaly because they believe CEO Michael Farrell will give them a better return on their investments.

Annaly lowered its dividend during the last two quarters. It is safe to assume that most RETI’s, especially mREITs, are affected by Operation Twist and its objective of maintaining low interest rates for an extended period of time. As Annaly, American Capital has also decreased its previous quarterly dividend from $1.40 to $1.25, an 11% decrease compared to 4% for Annaly’s previous dividend cut. In fact, dividend cuts in REITs did not only affect these two stocks because dividend reductions are seeing throughout the REIT industry within the last two quarters. Also keep in mind that dividends from REITs are constantly fluctuating. Looking forward, a major concern for income investors is the impending increase in short-term interest rates, which translates into lower income and lower dividends to shareholders. Despite this, both stocks are quite popular among investors seeking high yielders.

Final Thoughts

American Capital is no perfect stock, especially when taking into account the receivable inefficiency and the risk of increases in short-term interest rates. However, the stock has been performing well so far this year, returning just over 6% year-to-date. In addition, the strong bullish momentum from investors still holds; one of the factors for which the demand for American Capital stock is solid is due to the stock’s stellar yield of almost 17%. The stock is inexpensive and appropriately priced at a price to earnings ratio of just below 6.

Although volatility in the market has increased in the past few days, you may still profit by selecting an attractive stock such as American Capital. Looking forward, I expect the stock will continue to benefit from a slow but steady recovery in both, the overall economy and the real estate market, especially moving into 2013. Looking forward, the stock will appreciate in value as management strategically repositions itself to profit as new real estate and interest rates trends emerge.

Stocks Discussed: AGNC, NLY, ANH, ARR, CYS,
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