AGNC Investment Corp. (AGNC: $17)
Investment Research Report
|BMR Target Price||$20|
|BMR Sell Price||$15|
Coverage initiated June 25, 2019 at $17 in the HIGH YIELD portfolio.
Company Overview. AGNC Investment Corporation is a Maryland-based REIT that invests primarily in Agency residential mortgage-backed securities (MBS). Agency MBS is backed up by the Federal government through Fannie Mae, Freddie Mac and Ginny Mae, so they are deemed less risky than non-agency MBS (though the returns are generally lower as well).
Founded in 2008, the $9 billion company manages a $100 billion portfolio of assets, 85% of which maintain 30-year fixed loans, while 12% maintain 15-year loans or less. 1% of the portfolio holds a 20-year fixed loan, and 2% is non-agency.
Market Analysis. The Mortgage REIT (MREIT) market was hit hard last year as the double-whammy of rising interest rates coupled with broader macroeconomic concerns (driven mostly by the trade war with China) placed downward pressure on the entire industry. MREITs rely heavily on debt, so when the Fed starts raising rates, earnings compress and the companies understandably suffer. Additionally, with the albatross of a prolonged Chinese trade war hanging over the US economy’s head, investors were spooked during 4Q18, which led to the MREIT sector (along with pretty much the rest of the market) being sold off precipitously.
Yet here we are in 2019, and the Fed is signaling an impending rate cut. That bodes well for MREITs like AGNC, which has seen its stock rise 3% since the start of June. And while the China trade war is still ongoing, the risk of an acceleration actually grows less likely over time, given that we are fast approaching an election year. While the current administration remains volatile and unpredictable, all incumbent presidents try to avoid roiling markets during an election year – and since this president is so highly-dependent on the strong economy to win reelection, the likelihood is that he too will ease up on the trade war tactics. While it’s impossible to predict when the trade war will end, the chief concern going forward is whether the administration will ratchet up both the rhetoric and the tariff rates. Again, as 2020 nears, expect both the tough talk and tariff rates to be dialed down in an effort to buoy the stock market and amplify the strengthening economy.
Competitive Analysis. There are dozens of publicly-traded MREITs, though the only one that can be classified as large-cap is Annaly Capital (another BMR pick), at $13 billion. With a portfolio valued at over $100 billion, AGNC is at the top-end of the mid-cap class of MREITs. Mid-cap MREIT competitors are Blackstone Mortgage Trust, Chimera Investment Corporation, MFA Financial and New Residential Investment Corp. (also a BMR pick).
AGNC’s double-digit yield is amongst the highest in the industry (even after the dividend cut – more on that below), and its $9 billion market cap makes the company a relatively large player in the MREIT space.
Financial Analysis. The company had a strong 1Q19, as the broader market bounced back following the bleak 4Q18. Book value per share increased 4% from the prior quarter to $17.25. With the $0.54 of dividends per share issued during the quarter, that translates into an impressive 11% yield on the stock. Mortgages performed well overall during the quarter, which buoyed the entire MREIT industry. As a result, the company was able to increase its leverage rate to 9.3% from 8.4% during 1Q18. That helped push the total portfolio value to $102 billion. Net interest income came in at $164 million, a 27% YoY decline, which prompted management to cut its dividend (more on that below).
With $22 billion in cash and $87 billion in debt, AGNC has a 4:1 debt/cash ratio, which is extremely low for a REIT. Management issued over $200 million of new equity in 1Q19, so it is keeping the debt levels low which helps incur favorable borrowing terms. Given that the vast majority of AGNC’s debt is fixed-rate, strong terms are essential as they are locked in for decades.
Dividend CUT. Like industry leader Annaly, AGNC recently cut its dividend on the back of an inverted yield curve and a rough overall climate for returns in the REIT universe. While Annaly’s dividend cut was a hefty 17%, AGNC’s came in at 11%, from $0.18/share to $0.16/share. Like Annaly, AGNC’s management is looking to stay ahead of the curve here, in case the downward pressure on returns continues thanks to a flattened or inverted yield curve. However, with the Fed all but ensuring a rate cut in the near future, the likelihood of a sustained flattening of the yield curve is low. Should the yield curve widen and AGNC sees its return profile strengthen, it’s not out of the question for management to re-raise back up to the previous level.
Even with the dividend cut, the yield is a healthy 11.4% - better than most REITs or virtually any fixed income investment that offers anywhere near the stability and dependability of AGNC.
Stock Performance. The stock is down 5% YTD, which we view as a compelling buying opportunity. In over a decade of being publicly-traded, the current price point represents the lowest price in 10 years. The fundamentals simply don’t warrant this bleak of an outlook, especially given that macroeconomic conditions are improving, the Fed is lowering rates, and the double-digit yield is well-covered after the cut. The stock is in the gutter thanks to that dividend cut which came on the heels of the rough 4Q18, but we’re primed for a bounce here and are anticipating some rapid short-term upside once the Fed does indeed lower rates.
Of course, we don’t invest for the short-term here at The Bull Market Report, we are always thinking long-term. AGNC is a best-of-breed mid-cap MREIT with a stable 11.4% yield, and the company is about to start riding some macroeconomic tailwinds after over a year of headwinds. As a result, we’re expecting to get back into the $18-$20 range, where the stock traded for most of last year. That upside, plus the hefty yield will net you a very nice return, especially considering the limited downside risk here as the stock has bottomed out.
AGNC Investment is quite similar to Annaly Capital, our other MREIT holding. Both are fundamentally strong companies that offer substantial yields, so why not diversify into both, as opposed to relying on only Annaly going forward? We like the the bargain-basement price, and the fact that we’re coming off a dividend cut which means management has the payout under control going forward. With a Fed rate cut on the way, look for earnings and book value to improve, which will provide a nice boost to the stock. For investors looking to bank long-term double-digit returns with minimal downside risk, AGNC is a strong buy here as further price depreciation is unlikely.
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