HomeMost PopularWhy I Invested in Annaly Capital and the Potential for Growth

Why I Invested in Annaly Capital and the Potential for Growth

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High Yield, Low Risk Road Sign

Annaly Capital (NYSE:NLY) is a prominent mortgage REIT that, like other income stocks, has seen a decline in value recently. While Annaly has previously reduced its dividend when earnings were strained, I believe the current sell-off has been excessive.

After purchasing W.P. Carey (WPC) and Medical Properties Trust (MPW) at a discount, I have now added Annaly to my portfolio due to its attractive valuation and potential for revaluation as its net interest spread returns to positive territory. I see this as an oversold opportunity, especially considering the Relative Strength Index.

Previous Coverage of Annaly

Two years ago, I recommended Annaly as a buy for investors seeking a high-yield, long-term bond option. At that time, the mortgage REIT faced economic challenges due to rising interest rates, resulting in a negative net interest spread. However, I believe that the Federal Reserve will soon lower rates, which could drive earnings growth.

An Industry-Leading Mortgage REIT with a Strong MBS Portfolio

Annaly is one of the largest mortgage REITs for dividend investors. The company generates income from its investments in agency mortgage-backed securities, primarily long-dated (30-year) mortgages. As of the end of the June quarter, Annalyโ€™s agency mortgage-backed securities were valued at $71.6 billion.

Annalyโ€™s operating performance has suffered as a result of interest rate increases, with negative net interest spreads for two consecutive quarters.

The uptick in the Fed Funds rate has led to a significant decline in Annalyโ€™s net interest spread. In the June quarter, Annaly reported a negative net interest spread of 0.73%.

FY 2023

FY 2022

2nd quarter

1st quarter

4th quarter

3rd quarter

Net interest margin

-0.15%

0.09%

0.65%

1.42%

Average yield on interest earning assets

4.27%

3.96%

3.86%

3.47%

Average GAAP cost of interest bearing liabilities

5.00%

4.52%

3.71%

2.38%

Net interest spread

-0.73%

-0.56%

0.15%

1.09%

(Source: Author)

While Annalyโ€™s net interest spreads are concerning, I expect the companyโ€™s financial situation to improve as the Federal Reserve lowers interest rates. This should stabilize the mortgage REITโ€™s spreads and potentially increase its share price.

Valuation of Annaly Compared to Other Mortgage REITs

Annalyโ€™s shares have experienced a significant decline recently, likely due to weakness in the REIT sector impacted by higher interest rates. However, I see this as an opportunity for investors looking for potential recovery.

Currently, Annalyโ€™s shares are trading at a 16% discount to book value, compared to the historical average price-to-book ratio of 0.98X. Investors can currently buy Annaly at a 15% discount to its historical P/B ratio. This suggests that Annaly could trade at book value in the medium term, resulting in a fair value between $20-21 per share. With the current share price at $17.48, there is potential for a 14-20% upside.

Additionally, based on the Relative Strength Index, Annalyโ€™s shares are currently oversold, indicating potential for technical revaluation.

Risks Associated with Annaly

There are several risks to consider when investing in Annaly. The companyโ€™s earnings and net interest spreads have been declining in a higher-rate environment. There is also a possibility of a dividend cut and continued trading at a discount to book value if the REIT sector continues to struggle.

Final Thoughts on Annaly Capital

While I typically focus on growth companies, the current market conditions in the REIT sector present an opportunity for value investors. Despite the eye-catching 14.8% dividend yield, I am investing in Annaly because its shares are trading well below their historical price-to-book ratio. I believe there is significant potential for recovery, resulting in a potential upside of up to 20% within a year, excluding dividends.

The recent dip in Annalyโ€™s share price aligns with my belief that the Federal Reserveโ€™s interest rate changes will lead to a re-rating of the companyโ€™s shares. With oversold shares and attractive valuation, now seems to be the right time to take advantage of the dip!

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