Can You Trust Annaly Capital Management’s Distribution?
If you want to earn more investment income, it sometimes pays to pick through an unpopular corner of the stock market: dividend cutters.
Okay, I know what you might be thinking. Companies loath slashing their payouts. So if a management team reduces the dividend, it usually means something has gone wrong.
But here’s the thing: when businesses cut their dividends, investors stampede for the exits. That often allows you to scoop up good, albeit slightly damaged, assets at bargain prices. I sometimes compare it to shopping in the “scratch and dent” section at the furniture store.
Take Annaly Capital Management, Inc. (NYSE:NLY), for instance. This mortgage real estate investment trust (mREIT) has struggled in recent years. But with a dividend yield topping 10%, income hunters might want to give it a look.
Here’s why.
Annaly is pretty straightforward to wrap your head around. The partnership borrows money from investors and invests the proceeds into mortgages. Its profit comes from the difference, called the spread, between what Annaly earns in interest on loans and what it pays to its bondholders.
That business model, however, backfired last year. Simply put, the spread between short-term bonds and longer-term mortgages shrunk considerably in 2019. And by extension, so did Annaly’s profits.
Unitholders, unfortunately, paid the price. In May, Annaly Capital Management, Inc. cut its distribution by 17%. (Source: “Dividends,” Annaly Capital Management, Inc., last accessed January 14, 2020.)
That triggered a sell-off, sending NLY stock cratering five percent in value.
That distribution cut, however, has left the firm in a more sustainable financial position. For 2020, analysts estimate that Annaly’s core earnings will come in at $1.06 per share. Over the same period, the business will pay out $1.00 per share in distributions (based on its current dividend).
Generally, I like to see a wider spread between what a company generates in profit and what it pays to unitholders. But Annaly’s distribution looks sustainable for now.
Looking forward, Annaly Capital Management, Inc. could even begin boosting its distribution again.
In August 2019, the Federal Reserve began cutting interest rates. As you can see in the chart below, this has widened the gap between short- and long-term bond yields.
Chart Courtesy of StockCharts.com
So what does all this mean?
In a nutshell, Annaly now spends less in interest to fund its business. And by extension, that means more money should flow to the mREIT’s bottom line in 2020.
In short, income investors should generally avoid companies that have recently cut their dividends. But sometimes you can find good value in this group.
Annaly Capital Management, Inc. doesn’t have the safest yield in the world, but its dividend payments will likely keep rolling in for the next year or so.