2023-06-21 11:00:00 ET
Summary
- Arbor Realty Trust is set to join the S&P SmallCap 600 index, boosting investor confidence and creating more opportunities for index funds to gain exposure.
- The company has recovered significantly from its April lows, with CEO Ivan Kaufman demonstrating his stock-picking instincts by buying back stock at attractive valuations.
- With a forward distributable EPS of 7.6x and a forward dividend yield of 12.1%, ABR's valuation is still highly favorable.
- Pessimistic investors still holding on to short positions could be forced to cover rapidly as ABR recovers its uptrend.
Arbor Realty Trust, Inc. ( ABR ) investors received a welcomed boost as ABR is " set to join the S&P SmallCap 600 index." As such, it posted a gain of nearly 6% in post-market trading, recovering losses from yesterday's 3.1% decline in the regular session.
As such, the move should help bolster investors' confidence given ABR's inclusion, expected to take effect on June 23. It would also help create more opportunities for index funds to gain exposure to ABR, helping to improve buying sentiments as it remains markedly undervalued.
I highlighted in an article in November 2022 that cautioned investors to curb their enthusiasm as ABR's price action recovered after its steep October 2022 dive. Accordingly, it has underperformed the S&P 500 ( SPX ) ( SPY ) since then on a total return basis, despite its highly attractive dividend yield.
However, with the AI-driven rally looking increasingly likely to take a break, the market could turn its attention to well-battered real estate finance players like ABR, as the sector as a whole remains undervalued.
Moreover, ABR has recovered significantly from its April lows, corroborating management's prescience as it utilized its stock repurchase authorization, buying up $37M in shares in Q1 at an average price of 10.53. CEO Ivan Kaufman demonstrated his stock-picking instincts, seeing a highly attractive valuation dislocation as ABR traded well below its book value then. Kaufman added:
As the largest shareholder, I have a long-term perspective and believe that buying back stock at current prices is reasonable and intelligent. When considering valuation, if you apply a conservative dividend yield of 8%, which is within the market range, our stock could be valued at $21. - ABR FQ1'23 earnings call
Kaufman also returned to the open market and bought more shares in early May, reported as insider purchases, putting his money where his mouth is. I gleaned that buying sentiments have improved, which could have caused some short-sellers to cover. Accordingly, ABR's short interest as a percentage of float remains high at more than 17% as of the end of May.
Therefore, with the impending inclusion into the S&P SmallCap 600 index, some weak bearish investors could also take the opportunity to flee, further lifting the near-term upside in ABR.
Pessimistic investors are worried that the malaise in the commercial real estate market could engulf leveraged mREITs like Arbor Realty. However, they should not forget that Arbor has a significantly different funding structure than the regional banks that rely on short-term deposits.
Management reminded us that Arbor has " highly stable " liability structures. It recorded "$7.6 billion in non-recourse, non-mark-to-market securitized debt" in Q1. In addition, 70% of its outstanding secured indebtedness is based on securitized debt. In addition, its highly attractive pricing structure allows Arbor an effective way to deliver robust levered capital returns. Hence, Arbor doesn't face similar, similar deposit duration mismatch risks that affect the regional banks.
The company's well-diversified revenue streams from its structured and agency business help stabilize its distributable EPS. Notwithstanding, there are concerns about whether ABR's payout ratio could be affected moving forward, which could have elevated the recent pessimism.
The revised consensus estimates suggest that Arbor Realty could post a YoY decline in its distributable EPS through Q1'24. As such, I believe that the market has attempted to price in the impact of the Fed reaching the end of its unprecedented rate hikes, which bolstered ABR's interest income on its floating rate loans.
Yet, it should also help alleviate some pressure on borrowers, helping to improve their ability to commit to their loan repayments. The market could be pricing in a higher possibility of management reducing its dividend payout, which looks misplaced at the moment.
Unless investors expect a highly significant impact on its distributable EPS, the potential of that materializing is likely low. Moreover, the remarkable recovery from its April lows suggests that dip buyers are unfazed by the market pessimism, capitalizing on its below-book value valuation, which has since normalized.
ABR formed a triple dip in April, which attracted dip buyers to return with a vengeance as it surged toward its June highs.
As such, the entry points likely aren't optimal, with investors likely looking for the next pullback before buying more aggressively.
However, ABR's price action suggests that its April dip could have formed its "ultimate" bottom, leading to a reversal from a downtrend to an uptrend. With a forward distributable EPS of 7.6x and a forward dividend yield of 12.1%, ABR's valuation is still highly favorable.
Coupled with the potential of sector rotation from overstretched tech stocks to the undervalued real estate sector, I assessed that ABR remains in the earlier stages of a sustained medium-term recovery.
Investors with little or no exposure could consider a starting position, adding more if it pulls back further.
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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Arbor Realty: The Rally Is Just Getting Started (Rating Upgrade)