ACR - Ares Commercial Real Estate Corp: 16% Yield Rising Rate Tailwinds

2023-03-24 12:21:00 ET

Summary

• ACRE common yields 15.82%, and goes ex-dividend on 3/30/22.
• It benefits from rising interest rates.
• It looks oversold.

Looking for a high dividend stock that benefits from rising interest rates?

Ares Commercial Real Estate ( ACRE ) is a mortgage REIT with 99% of its loans being interest rate sensitive, whereas only 68% of its total debt is interest rate sensitive.

ACRE's management estimates that the company gains $.11 to $.18/share for every 1.00% rise in interest rates:

Company Profile:

ACRE is part of the Ares Real Estate Group, which has more than $51B in assets under management and more than 2,000 properties globally managed by over 240 investment professionals.

ACRE originates and invests in commercial real estate - CRE - loans and related investments in the US. The company provides a range of financing solutions for the owners, operators, and sponsors of CRE properties. It originates senior mortgage loans, subordinate debt products, mezzanine loans, real estate preferred equity, and other CRE investments, including commercial mortgage-backed securities. ACRE is required to pay its Manager a base management fee of 1.5% of ACRE's stockholders' equity per year.

ACRE's two largest exposures are in Office, 37%, and Multi-Family real estate loans, 22%, followed by Industrial, 11%, and Mixed Use loans, at 10%. Its geographic exposure is dominated by the Southeast, at 27%, Northeast, 24%, with the Midwest and West both at 19%:

The target investment size is $10 - $250M, Senior loans, usually with a three-year maturity and extension options. 99% of the loans are floating rate, and 98% are Senior loans.

ACRE's Loan Portfolio has an outstanding balance of $2.3B, comprised of 60 loans, with a weighted average unleveraged effective yield of 8.9%.

Earnings:

Q4 2022 had flattish revenue, with net income down 83%, due to a $19.4M provision for current expected credit losses. As of Dec. 31, 2022, ACRE had three loans held for investment on non-accrual status with a carrying value of $99.1M.

As noted above, rising interest rates are a tailwind for the company, as seen by its net interest margin rising over 27% in Q4 '22 and 24.7% in full year 2022.

Q4 '22 Distributable earnings rose 27.5%, while distributable EPS rose 7.3%, with the share count up 16% vs. Q4 '21. As with most other companies, interest expense was up in 2022, 56% in Q4, and ~32% for the full year.

Full year 2022 had a 4.7% rise in revenue, with net interest margin up 24.7%, and distributable earnings up ~22%. The share count rose 22% in 2022 - On May 20, 2022, ACRE closed a public offering of 7M shares of its common stock, generating net proceeds of ~$103.2M.

ACRE originated $725M of new loan commitments, with over 33% in the multifamily sector in 2022.

Dividends:

ACRE's board declared a $0.33 dividend and a $.02 supplemental dividend, both of which will go ex-dividend on 3/30/23, with a 4/18/23 pay date. At its 3/23/23 price of $8.85, ACRE's base yield is 14.92%, plus its supplemental yield of 0.90%, equals a total yield of 15.82%.

Its five-year dividend growth rate is 5.44%.

Distributable EPS was flat in 2022, at $1.55. Dividends/share rose 1.45%, as did the dividend payout ratio, vs. 89.03% in 2021. The 2022 dividend coverage ratio was 1.11X, vs. 1.12X in 2021.

ACRE has paid a base dividend of $.33/quarter since Q1 '19, with $.02/quarter supplemental dividends starting in Q1 '21:

Taxes:

Most of ACRE's 2022 distributions were characterized as ordinary dividends, with just $.035 characterized as capital gains. $1.3612 were listed as Section 199A dividends on ACRE's 1099.

Profitability and Leverage:

ROA and ROE both fell in 2022, but remained better than M-REIT industry averages. Management improved debt leverage, with debt/equity decreasing to 2.32X, and net debt/assets improving to 68.83%. However, EBIT/Interest coverage fell to 1.19X, vs. 1.68X in 2021, due to much higher interest expenses.

Debt and Liquidity:

As of Feb. 14, 2023, ACRE had ~$216M in liquidity, including $141M of unrestricted cash and $75M of availability under its Secured Funding Agreements.

ACRE had seven debt sources as of 12/31/23, with five being credit facilities from major banks. $1.02B, ~80%, of this debt matures in 2024 - 2025. There were also two facilities coming due in 2023, which had $0.00 outstanding as of 12/31/22.

It also had a $105M note payable coming due in 2025, and a $150M Senior Loan maturing in 2026.

Performance:

While the M-REIT industry has had a very rough time of it over the past year, ACRE has been beaten up even more, and has trailed the industry and the S&P 500 significantly in the past month, quarter, year, so far in 2023, and on a ~1 Year total return basis.

Analysts' Targets:

Earlier in March, a KBW analyst downgraded ACRE to Market Perform from Outperform on expectations that commercial real estate credit will undergo a hard landing as interest rates keep rising.

At $8.85, ACRE was 19.55% below analysts' lowest target of $11.00, and 30.8% below the $12.79 average price target:

Valuations:

ACRE's valuations are a mixed bag - its .65X Price/Book is a bit lower than the .82X M-REIT average, and its forward P/E is also somewhat lower, while its trailing P/E and Price/Sales are both higher than average. In an industry with very high yields, ACRE's total yield of 15.82% is even higher.

Parting Thoughts:

With 10 out of 18 Fed members now calling for ending rate hikes sooner than later, it may be possible that M-REIT's could get a reprieve sometime in 2022.

Of course, nobody, including the Fed, knows when they'll stop raising rates, which puts income investors in various quandaries. Will M-REIT's get more market support when rates stabilize, or not until rates start to reverse?

Do you start selling some of your "lower" high yield equities soon, and switch into government or corporate fixed income, where lower risk yields are becoming more attractive?

While ACRE looks very oversold, it may still be a falling knife. We advise adding it to your watchlist until there's more clarity in the market.

All tables furnished by Hidden Dividend Stocks Plus, unless otherwise noted.

For further details see: