NLY - Rithm Capital: This 12% Yield Is A Buy

Summary

• Rithm Capital has performed well in the current harsh environment.
• The dividend looks sustainable and offers a massive yield.
• RITM stock has upside potential, and the company might increase its dividend in the foreseeable future.

Article Thesis

Rithm Capital ( RITM ) is a high-yielding mortgage REIT. Unlike most of its peers, it has done well in recent quarters, however. The company's dividend is well-covered and offers a hefty return for income investors that are not afraid of buying this unloved high-yielder today.

Recent Performance

Rithm Capital Corp. has reported its most recent quarterly results in November. The company showcased revenues that were down year over year, but that still came in way higher compared to what the analyst community had expected. Rithm Capital has several avenues for revenue generation, including its mortgage origination businesses that it built out and/or acquired during the pandemic. With the Fed raising rates substantially in recent quarters, housing demand has waned, and Rithm's mortgage origination business has originated fewer mortgages -- that also holds true for other mortgage originators and is thus not a company-specific issue.

A decline in revenues was thus to be expected in the current environment, and yet RITM's revenue decline was smaller than what the analyst community had forecasted. That fits with RITM's history of outperforming expectations:

During five of the last five quarters, Rithm Capital has beaten revenue estimates, and the company also outperformed earnings per share estimates in three of those quarters, while hitting the consensus estimate in the other two quarters. There is thus a history of outperforming expectations -- or, one could also say that Wall Street has a history of underestimating Rithm Capital.

Rithm Capital also recorded a strong GAAP net profit, unlike during the previous quarter. But since one-time, non-cash items such as fair value adjustments and mark-to-market accounting can impact GAAP results significantly, it's more telling when we look at adjusted/non-GAAP results. During the second quarter of 2022, Rithm recorded a $400 million impact from the termination fee it paid to its former external manager when management was internalized.

Rithm Capital generated adjusted profits, or what it calls earnings available for distribution, of $153 million during the most recent quarter, which was up 5% sequentially, thanks to a better performance of its mortgage servicing business. Earnings growth isn't needed when a company trades as inexpensively as Rithm Capital does, one could argue, but earnings growth still is great, of course.

On a per-share basis, Rithm's profits came in at $0.32, which covered the dividend, which currently stands at $0.32 per share, easily. The coverage ratio for the quarter was 1.28, up from 1.24 in the previous quarter.

CEO Michael Nierenberg stated that he was happy with the performance of the company during the period [emphasis by author]:

“I am pleased to share that our Company had another great quarter. Book value quarter-over-quarter was essentially unchanged, despite the large sell-off in rates and the widening of credit spreads . Earnings available for distribution were 32 cents per diluted share, in line with prior quarters. Our emphasis continues to be on strategically growing the Company across the financial services landscape, managing risk with a macro view towards the future, and allocating capital accordingly to focus on attractive risk-adjusted returns .”

Book value being flat versus the previous quarter was a strong feat, as many other mortgage REITs were not able to deliver a similar performance. Competitors, such as AGNC Investment ( AGNC ) or Annaly Capital ( NLY ) have seen their tangible book values decline by 26% and 29%, respectively, over the last year. Meanwhile, Rithm Capital has seen its book value pull back by just 4% over the same time frame. With Rithm Capital paying out a dividend yielding more than 10% today, its economic return has been positive over the last year in a harsh environment, while that of most other mortgage REITs was deeply negative.

Rithm Capital's outperformance versus the mortgage real estate investment trust peer group is not pure luck, but rather the result of a relatively resilient business model. While many other mortgage REITs employ massive leverage and are heavily impacted by movements in mortgage REITs, Rithm Capital is more resilient versus different macro environments. Its mortgage origination business does well in low interest rate environments when demand for housing is strong due to cheap financing options. Mortgage refinancing by those that have mortgages with higher rates further drives business opportunities for Rithm's mortgage servicing business. On the other hand, RITM's mortgage servicing business benefits when rates are climbing and fewer people decide to refinance their mortgages. Rithm Capital's mortgage servicing rights portfolio has a longer average life span when there are fewer mortgages that are being refinanced. That means that RITM gets to collect the fees from this portfolio for a longer time, as fewer mortgage servicing rights are "lost" due to the underlying mortgage being refinanced. One could thus say that RITM has some built-in resilience, as at least one of its business units should do well in different interest rate environments -- when rates are high and/or rising, such as right now, the MSR portfolio will do well, whereas the mortgage origination business will do well when rates are low or declining.

This differentiates Rithm Capital from its peers and makes it a lower-risk pick, I believe. RITM is not risk-free of course, as the sell-off during the initial phase of the pandemic has shown. When markets became very illiquid and there was panic selling, Rithm Capital had to liquidate some assets at an inopportune time, which hurt its book value. The company has not yet fully recovered from that sell-off close to three years ago. But during more normal times, when markets are orderly and not panic-driven, Rithm Capital's business has below-average risks versus its mortgage REIT peer group.

A Hefty And Well-Covered Yield

As shown above, Rithm Capital covered its dividend at a solid rate of 1.28 during the most recent quarter. While that is good, coverage should improve further going forward:

While 2022 was most likely a down year for the company -- we don't have Q4 results yet -- it looks like profits will rise in the current year and beyond. Based on current estimates, Rithm Capital should be able to cover its current $1.00 per year dividend at a compelling rate of 1.4 this year. When we account for the fact that Rithm Capital has a history of outperforming analyst expectations, actual results might be even better. With shares trading for just $8.50 right now, Rithm Capital's dividend yield is 11.8%, which is highly attractive.

In 2024, Rithm Capital is forecasted to earn almost $1.50. That would not only make for a great dividend coverage ratio of 1.5 for an (m)REIT, but this also would imply a pretty low valuation -- based on those forecasted profits, Rithm Capital is trading at less than 6x next year's net profit today, which makes for an earnings yield of 18% at current prices.

With healthy and improving coverage, Rithm Capital could be positioned for some dividend increases in the next couple of years. The company has kept the dividend stable at $0.25 per share for six quarters. It thus does not look like management is extremely keen on raising the dividend every year. But with rising surplus earnings, the company might still decide to increase the payout over time.

Management could also decide to pursue other things with surplus profits. M&A is an option, but I personally would prefer share repurchases. There is a share buyback authorization worth $200 million in place, which would be sufficient to buy back 5% of the company's shares. With shares trading at a pretty low earnings multiple and well below the company's book value of $12.10, buybacks would be highly accretive. They would not only increase the earnings yield and per-share book value further, but they would also make the dividend even more secure over time. As the share count declines, total dividend payments decline even if the per-share dividend is kept stable.

Takeaway

Rithm Capital is doing well in a harsh environment. The dividend is very high and looks sustainable. With investors getting a yield of 12%, not a lot of share price growth is needed for RITM to be a fine investment. And yet, thanks to the fact that shares trade at just 0.7x book value, RITM could see its shares climb considerably over the years. With surplus profits likely climbing this year and in 2024, investors might see a dividend increase, although that is not guaranteed. Buybacks would be great at current valuations, but they are unfortunately not guaranteed, either. No matter what, the high yield with solid coverage makes this high-yielder attractive for income investors.

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