PMT - PennyMac Mortgage: Buy For Solid Dividend Yield And Potential Upside

2023-03-08 18:47:02 ET

Summary

• PMT reported a net loss of $5.8 million which is a substantial improvement compared to a net loss of $27.3 million in 4Q21.
• I believe PMT can distribute a cash dividend of $0.47 per share in each of the four quarters of 2023, which means an annual projected dividend of $1.88, representing a yield of 14.62%.
• After comparing the forward P/E ratio of 8.7x with the sector median of 9.98x, I think the company is undervalued.

Investment Thesis

PennyMac Mortgage Investment Trust ( PMT ) is a specialty finance firm and mortgage real estate investment trust focusing on residential mortgage loans and mortgage-related assets. It has recently reported its fourth-quarter results for FY2022 and underperformed its expectations due to volatility and changes in the market environment. I believe the company can regain momentum and perform well in the coming quarters due to the potentially increasing stability of interest rates and unique investment strategies. It pays a high dividend to its investors, which makes it an attractive investment opportunity for risk-averse and yield-hungry investors.

About PMT

PMT is a leading specialty finance firm & mortgage real estate investment trust specializing in residential mortgage loans and mortgage-related assets. Operating and investing activities of the company are largely conducted through PennyMac Operating Partnership, LP ((Operating Partnership)) and its subsidiaries . PMT is managed by PennyMac Financial Services ( PFSI ) under a management arrangement with PFSI's investment management subsidiary, PNMAC Capital Management, LLC. PMT's business consists of mainly four segments : Credit sensitive strategies, interest rate sensitive strategies, correspondent production, and corporate.

Credit sensitive strategies include CRT arrangements, subordinated mortgage-backed securities, distressed loans, and real estate. Interest rate sensitive strategies include investments such as MSRs, excess servicing spreads purchased from PFSI, Agency & non-agency MBS, and related interest rate hedging. As part of its correspondent production segment, it serves as an intermediary between lenders and the capital markets by purchasing, pooling, and reselling newly originated prime credit quality loans via PCM and PLS services or by buying, pooling, and reselling MBS.

It involves the acquisition of loans from mortgage originators who meet specific criteria regarding management experience, financial strength, risk management controls, and loan quality. According to Inside Mortgage Finance, PennyMac was the largest correspondent aggregator in the United States in 2022. Corporate operations include management fees, corporate expenses, and interest income.

Financials

The company experienced a downfall in its performance in the previous year, mainly resulting from volatility and a decline in the origination market. It has recently reported its fourth-quarter results for the year 2022. It has reported a net loss of $5.8 million which is substantial improvement compared to a net loss of $27.3 million in 4Q21. The impacts of fair value changes in interest rates and credit-sensitive strategies mainly drove the net loss.

The net loss resulted in a net loss per share of $0.07, compared to a net loss per share of $0.28 in the same quarter of the prior year. The company reported a book value per common share of $15.78, which is a decline of 2.47% compared to $16.18 in the prior quarter. A total of $6.8 billion in unpaid principal balance was recorded in PMT’s account in 4Q22, which is a decrease of 34% as compared to 3Q22 as a result of certain conventional loans sold to PFSI.

The company also recently reported full-year 2022 results. It reported a net loss of $73.3 million, a substantial decline compared to a net income of $56.9 million in FY2021. The net loss resulted in a net loss per share of $1.26. The company reported a net investment income of $420.3 million, a 38.34% YoY decrease compared to $303.8 million in FY2021. It ended its quarter and year with $111.86 million in cash.

Though the company’s performance has not met its expectations due to volatility and adverse conditions, I believe that we can expect positive results in the coming quarters due to factors such as tightening credit spreads in the current year and increasing stability of interest rates which can further help the company to generate high loan volumes by capturing additional market share. It can also help the company to sustain its ability to pay attractive returns to its shareholders, which I will discuss in the next section.

Dividend Yield

PMT stock has managed to sustain its dividend payout over the past many years, which signals the good positioning of the company. In the previous year, it distributed a cash dividend of $0.47 in the three consecutive quarters and a cash dividend of $0.40 in the last quarter, which makes the annual dividend $1.81, representing a high dividend yield of 14.07%.

As we can see in the above chart, before 2020, the company maintained a stable history of a quarterly dividend payment of $0.47, which is an annual dividend payment of $1.88. Observing the current market environment and coupled with my belief in the increasing stability of interest rates, I believe the dividend payment can again reach the pre-covid levels. That is why I am estimating a cash dividend of $0.47 per share in each of the four quarters of FY2023, which makes the annual dividend $1.88, representing a dividend yield of 14.62%.

I think this high potential dividend yield makes the company an attractive investment opportunity, especially for yield-hungry investors and risk-averse investors looking for income earning opportunities. In addition, I believe it is a great investment alternative for retired investors who generally have a low-risk appetite.

What is the Main Risk Faced by PMT?

The company’s business is highly exposed to the risk of fluctuations in interest rates. Interest rates are affected by many factors, such as inflation fluctuations, changes in monetary policies, and adverse economic conditions. If the interest rates increase, it could negatively impact the company’s loan production volumes, leading to the contraction of its profit margins. If the interest rates decrease, it can cause a large number of borrowers to refinance, which can result in a loss for the company.

Valuation

The company has underperformed its expectations mainly due to volatility and adverse conditions. I believe we can expect positive results in the coming quarters as a result of the increased stability of interest rates. According to the seeking alpha, the EPS for PMT for FY2023 might be $1.48 in FY2023. After considering all the above factors, I believe the seeking alpha’s estimates are accurate. The EPS of $1.48 gives the forward P/E ratio of 8.7x.

After comparing the forward P/E ratio of 8.7x with the sector median of 9.98x, I think the company is undervalued. I believe the company might gain significant momentum due to the changing market environment and help it to trade above its current P/E ratio. I estimate the company might trade at a P/E ratio of 10.5x, giving the target price of $18.06, which is a 40.43% upside compared to the current share price of $12.86.

Conclusion

PennyMac Mortgage Investment Trust is one of the largest specialty finance firms in the United States, focusing on mortgage-related assets. The company is exposed to the risk of fluctuations in interest rates which can contract its profit margins. It has recently reported its fourth quarter and full-year 2022 results, which were negatively impacted by volatility. I believe the company can gain momentum back in the coming quarters due to tightening credit spreads and increasing stability of interest rates.

It pays attractive returns to its investors in the form of dividends, which makes it an attractive investment opportunity for risk-averse and yield-hungry investors. I believe investors can buy this stock for a solid dividend yield and potential upside. After considering all the above factors, I assign a buy rating to PMT.

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