2023-11-28 08:30:00 ET
Summary
- Annaly Capital Management investors experienced a decline in October 2023, but dip buyers returned with high conviction, anticipating a sustained bottom.
- The stock remains in a long-term downtrend, but there may be speculative opportunities for a mean-reversion rally.
- The company's operating performance suffered in Q3, leading to concerns about a potential dividend cut, but NLY's risk/reward profile is still attractive.
- I argue why the $15 level remains resilient for NLY, despite the recent scare. Therefore, I'm confident that the worst in NLY's steep decline is likely over.
- Supported by a dividend yield of almost 15%, NLY holders have a significant margin of safety at the current levels.
Annaly Capital Management (NLY) investors endured a rude shock in October 2023 as holders capitulated, compelling a breakdown of NLY's October 2022 lows ($15 level) before bottoming out. As a result, while my previous upgrade on NLY seemed premature, given the steep surge in long-term yields in October, NLY buyers returned with high conviction, anticipating another sustained bottom.
NLY bears could argue that the stock of the leading mREIT remains in a long-term downtrend. That's true. As a price action investor, I've learned never to go against a long-term trend, as NLY recently broke its $15 bottom.
However, speculative opportunities can still be appropriate, betting on a mean-reversion rally if buying sentiment is robust. Given Annaly Capital Management's scale and market leadership, investors shouldn't rule out tailwinds emanating from a potential rate hike reversal by the Fed in 2024, as it could have reached the peak of its hiking campaign.
Management has been preparing for that possibility, moving its hedges further out in duration. As a result, Annaly Capital Management adjusted its hedges, with " over 75% of the hedge duration now focused on the 7- to 20-year part of the yield curve." The move aligns with "the duration profile of the company's assets."
Despite that, its operating performance suffered in Q3, given the surge in short-term rates, affecting its earnings available for distribution or EAD. Accordingly, the company delivered EAD per share of $0.66 in Q3, "negatively affected by the continued rise in repo." Management telegraphed that it was also affected by the adjustment in its hedges, as it "actively added longer-end treasury features early in the quarter and as front-end swaps matured."
As a result, its dividend payout ratio surged to more than 98% last quarter, leading to a surge in investor anxiety about a potential dividend cut. The valuation de-rating in Q3 is apt, given the company's weak performance as its book value per share declined to $18.25, down 12% QoQ. Analysts' estimates suggest Annaly Capital Management's book value per share might not bottom out in FY23, projecting a further fall in 2024, reaching $17.67.
Moreover, the company's strategy of betting on a rate cut in 2024 could backfire. While the market has likely anticipated a less hawkish Fed, Jerome Powell and the FOMC will likely remain in data-dependency mode. In other words, NLY holders might need to brace for more pain if the data suggests a "higher-for-longer" posture is necessary to keep the US economy on track to meet the Fed's medium-term inflation targets.
As a result, I believe management's caution about not "providing guidance beyond 2023" is apt, considering these uncertainties. While NLY's forward dividend yield of 14.6% seems appropriate, I don't expect a significant upward valuation re-rating in the near- to medium-term. The company also stressed that the supply risks from the Fed's tightening have not been resolved. Management indicated that its "primary concern" remains focused on the "significant supply of treasury securities expected to enter the market next year." The company stated $1.7T in net treasury insurance and a "runoff of approximately $900 billion in treasuries and Agency MBS." As a result, structural headwinds in the Agency MBS market are expected to dampen investor sentiment on NLY.
Despite that, NLY dip buyers returned aggressively in early November to help it stem a further slide below the $15 level. As a result, that level has held resiliently, suggesting the worst could be over. However, I assessed that the $21 level is expected to be the critical resistance zone in the near- to medium-term suggesting investors should be cautious about adding too close to that level.
While the risks of a dividend cut cannot be ruled out, I gleaned that NLY's peak pessimism at the $15 level suggests the market has likely priced in significant uncertainties. As a result, I gleaned that the risk/reward profile of NLY at the current levels is still attractive, bolstered by an appealing forward dividend yield.
Rating: Maintain Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Annaly Capital: Significant Margin Of Safety With A 14.6% Dividend Yield