2023-06-12 12:36:56 ET
Summary
- AGNC investors returned with vigor in late May, helping to stem a more than three-month decline from its February highs.
- The Fed is on track to pause its unprecedented rate hikes, which could encourage more buyers to return as they anticipate less hawkish conditions moving ahead.
- AGNC remains deeply undervalued, trading well below its 10Y averages. However, the discount is likely justified, given the recent volatility and Fed's rapid hikes.
- However, I assessed that buyers helped AGNC bottom out in May at a higher level than its previous lows in October 2022. As such, AGNC is increasingly likely to grind higher from here.
- Buyers still waiting on the sideline should capitalize on the valuation dislocation before it reverts subsequently.
I cautioned investors in leading mREIT AGNC Investment Corp. ( AGNC ) back in February to brace for impact as we headed into the Fed's interest rate decision cycle back then. I also downgraded AGNC despite its seemingly attractive valuation, as I noted that its buying momentum looked increasingly likely to top out.
Accordingly, AGNC fell over the next three months before bottoming out in late May. The recent banking crisis has created upheavals over Agency MBS spreads as investors parsed a further fallout in the market. Furthermore, AGNC's tepid earnings release in April corroborated its weaker sequential operating performance, as its tangible book value per share, or TBVPS, declined further.
However, investors who bought AGNC's recent May lows are likely looking past the mREIT's struggles with the Fed's unprecedented rate hikes. Fed Chair Jerome Powell and his colleagues have the opportunity to set up a pivotal FOMC announcement this week, as the market expects the Fed to pause its rate hikes (80.5% probability as of June 12).
Management's commentary in April is in line with the market, as it anticipates that the " repricing [of Agency MBS] is in the late stages." However, management cautioned that "spreads could remain attractive until the tightening cycle is over."
Therefore, I assessed that while management remains optimistic, investors must still be cautious over the macro backdrop as economic forecasters diverge in their assessments. Despite that, I gleaned that dip buying activity in AGNC over the past three weeks has been constructive, as buyers look to return AGNC into an uptrend bias.
Members of my service know that I've been in the bullish camp since October 2022, when the S&P 500 ( SPX ) bottomed out. I alerted my members on October 21 that "we have the bullish reversal condition that we need. So, we are good to go." We also took advantage of the regional banking crisis in March and April, as we capitalized on the valuation dislocation in the financial sector despite the doom and gloom.
Hence, bullish AGNC investors are likely keen to know whether the current levels are still attractive to add more exposure, or should they wait? I believe the critical question is whether they agree with the recent dip buying sentiments suggesting that AGNC likely bottomed out in October last year, followed by another steep pullback to form its May lows.
AGNC last traded at a forward distributable EPS multiple of 3.9x, well below its 10Y average of 7.3x. Moreover, its forward dividend yield of 14.4x is well above its 10Y average of 11.8%. Hence, I remain confident that significant pessimism has been priced into AGNC, which is justified.
Given its leverage (7.2x of tangible net book value as of Q1, down from 7.4x in Q4'22), I think it's critical for the market to reflect execution and liquidity risks. Despite that, the company reminded investors that it had cash and unencumbered Agency MBS holdings representing 57% of its tangible equity in Q1.
As such, I concur with the recent buying sentiments that the worst in AGNC has likely been priced in. However, convincing momentum investors to return confidently remains challenging, as AGNC is still projected to deliver a decline in its distributable EPS through FY24.
As seen above, AGNC formed a higher low in May 2023, as buyers returned to stanch a further slide toward its October 2022 lows. I urged investors back then to buy, given the steep selloff, which decimated holders, but also improved its valuation significantly.
However, AGNC's February highs demonstrated that sellers remain in control of its medium-term downtrend bias. As such, I assessed that for AGNC to reverse its bearish bias, momentum buyers must return to force a decisive breakout above the $10.50 level before a potential early uptrend reversal signal can be established.
Notwithstanding, I expect AGNC to continue grinding higher from here. Coupled with an attractive forward dividend yield and a reasonable margin of safety from the $10.50 level, investors should consider taking advantage of AGNC's recovery.
Rating: Buy (Revised from Hold). 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.
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AGNC: Still Ridiculously Cheap Due To The Fears (Rating Upgrade)