Annaly: A quintessential income stock

With a double-digit yield, risk-oriented investors should consider this mortgage REIT.

By TheStockAdvisors Apr 29, 2013 11:16AM

Miniature home on sheet of percent signs © Comstock Getty ImagesBy Genia Turanova, Leeb Income Performance

The highest-yielding stock in our portfolios, Annaly Capital Management (NLY), is yielding in excess of 11%. This mortgage REIT is in fact a quintessential income stock.

Since its 1997 IPO, Annaly has dramatically outperformed both the S&P 500 ($INX) and the financial sub-index. With returns having come mostly from dividends, the main question concerns their future safety.

This is not as simple as it might seem at first glance. Most important, for a high-yielder like Annaly, we must consider the expectation (or lack thereof) for the dividend per share to remain stable. After two dividend cuts in 2012, this question is key.

But what we must also include in the decision to buy the stock (or not) is the relative attractiveness of the dividend in this market -- even given potential for further declines -- and whether the current price justifies buying these shares now.

Since its IPO, the company has paid over $9 billion in dividends, but it has not maintained consistent year-on-year growth in total payouts. As could be expected, the stock price generally reacted badly in years that it paid smaller sums.

This was also the case last year, as the company's earnings fell, and it cut its dividend (from $0.57 to $0.45 quarterly) during the year. The untimely death of the company's founder and CEO didn't help the stock's performance either.

Having said all that, we believe, the current stock price justifies further purchase -- even though Annaly's quarterly dividend is likely to decline to $0.35 (a cut also generally anticipated on Wall Street). The fact is, the resulting 9% yield would still be attractive.

And were the stock price itself also to fall further, we expect it to eventually recover, given the rarity of such high, generally healthy yields.

The company owns and manages a portfolio of mortgage-backed securities. It generates net income to distribute to stockholders from the spread between interest income on its investment securities and the costs of borrowing to finance acquisition of investment securities -- and from dividends received from subsidiaries.

Its portfolio, to date, has been almost entirely invested in U.S. government agency mortgage-backed securities and debentures, a lower-risk (but also lower-yield) mortgage market sector than others.

Annaly finances its acquisitions via net proceeds of equity and convertible note offerings -- as well as borrowings under repurchase agreements according to changes in short-term rates on cash and notes. Consequently, the company is very sensitive to interest rates fluctuations.

Rising long-term rates can be expected to raise returns on new investments and lower prepayments (and lower prepayment risk); meanwhile, the portfolio's book value will likely decline.

If short-term rates were to rise, financing costs would also increase. In 2012, Annaly's net interest rate spread fell from that it enjoyed in 2011 (1.29% vs. 2.09%).

But the company's investments reside in a relatively lower-risk real estate market segment -- a plus for us. Also, the company maintains only moderate leverage (at the end of 2012, Annaly's debt-to-equity ratio was 6.5:1).

Plus, the company is repurchasing stock: it has authorization to buy up to $1.5 billion worth of outstanding common shares (and in the first two months this year, it purchased some $400 million); this will further support the share price. Therefore, it remains a recommendation at its current levels.

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Apr 29, 2013 3:39PM
For the past three years, NLY's dividend has been significantly greater than it's earnings.  It's earnings/share record over the past decade looks like that example in Mary Buffett's Buffettology of an earnings record of a stock you should NOT buy.  From 2012 to 2003 in dollars/share: 1.71, 0.37, 2.04, 3.52, 0.64, 1.31, 0.44, -0.19, 2.03, 1.94.  The 2012-10 dividends were 2.05, 2.51, 2.76, which were 120%, 678%, and 135% of earnings.  The article assumes the dividend will fall to 4 x $0.35 = $1.40 annually, which the article notes is a 9% yield. Take out one year of $3.52 earnings, and the other 9 years average $1.14 per year, $1.04 for the last two years.  I don't see that $1.40 dividend as likely to last - nor the stock price.
Apr 29, 2013 8:34PM

Have owned Annaly for a few years, plus another REIT and recently bought in another..

We owned Chimera(CIM) a sister stock to NLY, but sold about 18-24 months ago..

And recently within last 6 months sold a third or half of our NLY position..

I guess I really do not need to give further commentary..

Still not TOO BAD of a Company or REIT, que sera,sera..

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