Annaly Capital Management (NYSE: NLY ) has carved a name out for itself as a high-yield income play in the mortgage REIT sector.
With a market capitalization of $10.50 billion and an operating history since 1997, Annaly Capital Management has become an institution that is known for delivering double-digit dividend yields to investors.
Though Annaly Capital Management has reduced its absolute dividend payout substantially since the first quarter of 2010, the mortgage REIT remains an attractive long-term income play on a relative valuation basis. Its current dividend yield stands at 11% and the stock trades at a 10% discount to book value.
In addition, there is a good chance that its dividends have now bottomed. A return to book value growth could spur an increase in quarterly dividends once again.
The low interest rate environment over the last couple of years has certainly added to the investor-appeal of mortgage REITs as high-yield income structures.
Persistently low interest rates caused traditional fixed income investments such as corporate or government bonds to be unappealing investment choices. Instead, investors who rely on regular cash to fund their living or retirement expenses gravitated toward the high-yield mortgage REIT sector.
High-yield income structures, whether they are REITs or business development companies (BDCs), are required to pay out most of their earnings (at least 90%). In turn, this means that the majority of total returns from these investments will come in the form of dividends and not capital gains.
In other words, Annaly Capital Management is unlikely to trade at a serious premium to book value. The mortgage REIT currently trades at a 10% discount to its first quarter book value of $12.30 per share, and I expect a P/B valuation in the range of 0.9-1.1 times over the course of 2014 amid higher interest rates. Historically, Annaly has traded at a roughly 10% premium to book value.
Higher interest rates ultimately mean more competition from other, high-yielding asset classes such as corporate bonds. This could put more pressure on the values of mortgage-backed securities going forward.
True dividend champion
There are a variety of ways to look at a company's attractiveness as a dividend play and its ability to pay shareholders a recurring stream of income: the payout ratio, dividends paid on an absolute basis, the dividend yield or -- better yet -- cumulative dividends paid out over a longer period of time.
In our particular case, Annaly Capital Management has churned out a massive amount of dividends over the last seventeen years. Since the mortgage REIT was founded in 1997, Annaly Capital Management has paid more than $11 billion in dividends to shareholders with large yearly increases during the Great Recession.
However, Annaly Capital Management shareholders have seen a dramatic cut in distributions over the last couple of years as the mortgage REIT faced headwinds from the interest rate front which cut into the REIT's profitability.
Quarterly dividends reached a peak in the first quarter of 2010 when Annaly Capital Management paid $0.75 per share while dividends have subsequently corrected sharply. The mortgage REIT currently pays $0.30 per share, the lowest quarterly amount since October 2007 (which saw a payout of $0.26 per share.)
However, Annaly Capital Management has held its dividend payout steady at $0.30 for three consecutive quarters -- including the July 31, 2014 dividend payment. This could be a signal that dividends have bottomed out.
This really depends on the management team's desire to increase its leverage levels and add more securities to juice the amount of cash flow available to be paid out as dividends.
This would be the most credible signal yet that dividends have seen their lows.
Ultimately, Annaly Capital Management is an attractive long-term income vehicle that historically has paid an increasing amount of dividends, and currently continues to yield double digits at 11%.
Its history of above-average total returns, bottoming dividend payments, and a justifiable P/B valuation of 0.9 times continue to make Annaly Capital Management a top choice in the mortgage REIT sector for long-term income investors.
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