Bear of the Day: American Capital Agency Corp (AGNC) - Bear of the Day
26 November 2013 - 8:54PM
Zacks
Mortgage REITs (mREIT for short) have long been favorites of
dividend investors, and especially before taper concerns came back
into the picture. Securities in this space often pay double digit
yields, and with such a sluggish market for income, these were
preferred picks by many.
The structure of mREITs also increased their appeal when rates were
stable. That is because mREITs generally borrow at short-term rates
and then invest in longer term securities. So in this strategy, a
big spread between short term and long term rates is key for
strength in their business model.
However, as taper talk has resumed the spread has shrunk between
these two key figures, while there is a threat of further
compression in the weeks and months ahead as well. This has been
terrible news for the space and many have jumped out of stocks in
this corner of the market as a result. In particular, one to watch
for further losses is
American Capital Agency Corp
(AGNC).
AGNC’s Recent Earnings
The latest earnings report for AGNC was pretty terrible by any
estimation. Third quarter results came in at 61 cents a share,
falling well short of the consensus estimate of 84 cents a share.
Results also represented a decline sequentially too, as last
quarter saw 66 cents of earnings, while the year ago period saw 79
cents a share.
Especially concerning from the report was the average yield on its
agency security portfolio, which slumped by 33 basis points down to
just 2.59%. Meanwhile, its cost of funds which was more or less
stable—down just four basis points—to 1.39%. This means that the
interest rate spread declined by 29 basis points to just 1.20%,
eating into the company’s profits and future prospects as well.
Live by the dividend, Die by the dividend
Dividends, one of the main reasons to buy a mortgage REIT, have
also been on the decline for AGNC. The firm’s Q3 dividend came in
at 80 cents a share, a nearly 24% decline from the previous
quarter, and when annualized, a huge drop from previous years.
Thanks to declining margins and slumping yields, investors have
sold off AGNC in droves. Shares of the company are down more than
30% YTD, and the stock is within striking distance of its 52 week
low as well.
Estimates are falling too
And based on the latest earnings report and the sluggish trend in
the interest rate market, many analysts seem to believe that the
slump isn’t over for AGNC. In fact, analysts have been slashing
their forward estimates for AGNC to the bone as of late, suggesting
that more pain is on the way.
The magnitude of these revisions has been colossal too, with
estimates for the current year falling from $6.92/share 30 days ago
to just $4.37/share today. Next year figures are also depressing,
with estimates falling from $3.26/share 30 days ago to just
$2.60/share today, representing a decline of over 20%.
Due to these factors, and a horrendous history at earnings
season—four straight misses of at least 11%-- we have no choice but
to assign AGNC a dreaded Zacks Rank #5 (Strong Sell). So we are
looking for more underperformance from this struggling company to
close out the year, and especially so if the interest rate spread
compresses even more in the coming months.
Other Options
Unfortunately, the mREIT industry has a terrible industry rank,
coming in at just 229 out of 260, putting it near the bottom 10%.
Yet despite this poor rank, there is one company that appears
well-positioned in the space and could actually be a decent pick;
Ellington Residential (EARN).
This company has a Zacks Rank #1 (Strong Buy) and this actually
represents an increase from a week ago when the stock had a Rank of
3. The firm also saw a strong surprise in the previous earnings
release, and solid estimate revisions higher too.
So if you are looking to stay in the mREIT space, consider going a
little smaller and focusing on EARN. This company has a double
digit yield and it could be better positioned than the struggling
AGNC at this time.
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