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Annaly Capital: An Enticing Dividend, Hard to Trust
Stock Analysis & Ideas

Annaly Capital: An Enticing Dividend, Hard to Trust

Annaly Capital Management (NLY) is a leading diversified capital manager that invests in, and finances, residential and commercial assets.

The company’s primary business objective is to generate net income for distribution to its shareholders, and optimize total returns through prudent management of its diversified investment strategies.

Annaly is an internally managed corporation that has elected to be taxed as a real estate investment trust (REIT).

Due to the company’s clear objective to maximize income for its shareholders, Annaly has historically appealed to income-oriented investors. The stock currently yields a substantial 10.2%, a massive yield in the current environment, but how safe is the dividend?

I am neutral on the stock. (See Analysts’ Top Stocks on TipRanks)

Recent Performance, Dividend Safety

The COVID-19 pandemic shook mortgage REITs, which typically face increased risks versus traditional rates.

Being susceptible to interest rate fluctuations, the net income levels of mortgage REITs can be wildly cyclical, which creates an environment of steep uncertainty during market downturns.

Due to interest rates moving unfavorably over the past few years, Annaly’s investment income yield (interest income minus interest expenses) has come under pressure lately. In other words, the company would need to take on additional leverage to offset any declining results.

In its most recent Q2 results, Annaly reported a 4% quarterly economic loss versus a 2.8% economic return in the previous quarter.

Economic leverage stood at 5.8x, down from 6.1x the prior quarter, but still substantially high.

Due to current distributions being borderline-sustained at this point, book value per common share came in at $8.37, down from $8.95 in the preceding quarter.

Annaly’s net interest margin, excluding PAA, came in at 2.1% compared to 1.9% in the previous quarter, while its net interest spread during the period, again excluding PAA, came in at 1.93%, up from 1.84% in the prior quarter.

While Q2’s performance was rather promising, with margins slightly increasing from their previous lows, investors should be wary of the safety of the current dividend. As you can see in the graph below, the REIT has slashed its DPS multiple times over the past decade.

Source: SEC filings, Author

For the company to avoid any further book value losses, further DPS cuts are not unlikely if Annaly’s investment spreads do not improve soon.

Despite last year’s headwinds, the majority of mREITs fled away from substantial damages by utilizing a lower amount of derivative instruments when compared to 2018-19. Hence, the modest DPS.

However, an unfordable market environment could easily hurt the company’s financials in the future.

While the double-digit yield is certainly enticing, and it could easily cover for any equity/book value losses in the short term, Annaly’s investment case remains quite speculative.

Wall Street’s Take

Turning to Wall Street, Annaly Capital has a Hold consensus rating, based on one Buy, three Holds, and zero Sells assigned in the past three months. At $8.77, the average Annaly Capital price target implies 1.4% upside potential.

Conclusion

Annaly likely remains the most compelling mREIT among its peers under the ongoing market circumstances.

The stock is not trading with a steep premium to its book value, while the yield is certainly too generous to ignore. The company has also historically posted greater profitability and safety prospects versus its industry peers.

Due to its sheer size (multiple times larger than most of its peers), Annaly is likely to perform better during downturns in the industry. Still, the stock can hardly be blindly trusted, and investors need to constantly monitor it as soon as it has a place in one’s portfolio.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

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