STWD - Starwood Property: Rising Above The Mayhem

2023-06-19 10:00:00 ET

Summary

• Starwood Property stock has recovered most of its March losses, with its valuation normalizing further as buyers capitalized on its attractive forward dividend yields in May.
• Management kept its income investors on board by demonstrating confidence and resolve to retain its dividend. As such, dip buyers likely garnered the confidence to buy more.
• STWD's forward dividend yield of 9.9% is still not aggressive and has a reasonable buffer against the 10Y Treasury yield, which last printed at 3.77%.
• With STWD surging over the past five weeks, a pullback is expected, but I assessed that STWD likely bottomed out in May. Investors should capitalize on a possible dip to buy more.

Investors in leading diversified mREIT Starwood Property Trust, Inc. ( STWD ) experienced a massive battering in March as the market de-rated Starwood and its peers.

However, dip buyers who braved the storm in the recent banking crisis and bought its steep pullback have benefited, as STWD has recovered most of its March losses from price-performance and total return basis. I also gleaned that STWD's price action indicates a significant bullish thrust over the past five weeks but could find stiff resistance soon.

I also reminded investors to " load up on the dip " in an article written before the SVB debacle engulfing commercial real estate players. With the remarkable recovery, STWD's valuation has normalized further, as buyers capitalized on its attractive forward dividend yields in May.

At its Q1 earnings call in May, management's constructive commentary likely bolstered investors' confidence that the company has the liquidity and portfolio diversification to navigate the commercial property headwinds.

As such, the company needs to keep its income investors onside, even as the market reflected substantial headwinds and challenges in its valuation. Therefore, with income investors holding the defense line robustly, dip buyers likely accumulated and helped bolster STWD's consolidation zone from March to May, as highly-respected CEO Barry Sternlicht stressed:

The shape of the curve is going to help force capital into longer-term assets, which will look really good as the yield curve inevitably flattens. So I think this is a great opportunity for people and for us, but we do -- first and foremost, we are always been predictable and safe, and we want to protect, if we can at all cost our dividend. So we're not going to be cowboys, but it is accretive to buying the stock, obviously, at these levels to our dividend. - Starwood Q1'23 earnings call

Management assured investors that its CECL reserve is reasonable, although there were concerns that it could be too low. An analyst on the call highlighted his worries that the market could be pricing in "nervousness regarding potential credit issues and the possibility of a significant increase in the CECL reserve."

Does it make sense? The crux of the issue lies with whether the market is confident enough with management's basis of expecting full repayment from the five loans that were downgraded into "the higher risk-rated categories (4 and 5), of which 3 were US office loans."

With the malaise engulfing office properties, the market could continue to reflect a substantial discount against STWD's long-term valuation to reflect the brewing risks.

Notwithstanding, management stressed that office loans accounted for "only 13% of total assets, with just 10% in US office, including life sciences." It also highlighted "no loan exposure in any asset class in San Francisco," which has been significantly impacted by structural headwinds.

In a recent article, the New York Times reported that the battering seen in San Francisco office properties had affected its retail malls, as retail tenants struggle to cope with much lower post-pandemic spending. Therefore, I assessed that the market is expected to remain cautiously positioned in the near term. Investors are expected to evaluate further the impact of the structural and cyclical headwinds, which isn't clear at this point, worsened by the uncertainties from the regional banking fallout.

After a remarkable surge over the past few weeks, investors should anticipate a welcomed pullback, giving dip buyers another opportunity to add more positions.

I gleaned that STWD's May lows likely indicate a double dip, potentially marking the end of its downtrend bias. That thesis will be put to the test as STWD moves closer to re-testing its 50-week moving average of MA (blue line), with expected resistance.

Note that the 50-week MA has consistently rejected STWD's recovery since it lost the support of that line in early 2022. Therefore, if our thesis plays out accordingly, seeing STWD regaining control of the 50-week MA, it should indicate that STWD bottomed out in May, continuing its recovery toward an uptrend.

With STWD's forward dividend yield of 9.9% set against its 10Y average of 8.9%, it's still not aggressive and has a reasonable buffer against the 10Y Treasury yield, which last printed at 3.77%.

However, investors who prefer a better entry point can consider waiting for a pullback first.

Rating: Maintain Buy.

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

We Want To Hear From You

Have additional commentary to improve our thesis? Spotted a critical gap in our thesis? Saw something important that we didn’t? Agree or disagree? Comment below and let us know why, and help everyone in the community to learn better!

For further details see: