Orchid Island Capital Stock: 18%-Yielding mREIT Could Have 20%+ Upside
December 6, 2024
Orchid Island Pays Dividends Monthly
Few industries have been as hindered by high interest rates as real estate investment trusts (REITs)…or mortgage REITs (mREITs), in particular.
Generally, REITs need to borrow a lot of money to increase their portfolios. Higher interest rates can cut into profit margins and profitability, which negatively impacts a REIT’s earnings and dividends.
mREITs are especially susceptible to higher interest rates, so they should do well in a lower interest rate environment. Lower interest rates bring potential homeowners off the sidelines, which means that mREITs can purchase mortgage-backed securities (MBS) at better terms.
The current interest rate environment is allowing mREITs to able to borrow capital at far lower interest rates than what the mortgages are actually paying. This should give an mREIT like Orchid Island Capital Inc (NYSE:ORC) the opportunity to buy more debt for the same or even less than it could in a high-interest-rate environment and, ultimately, increase its monthly dividends.
Vero-Beach-Florida-based Orchid Island Capital is an mREIT that invests in residential MBS on a leveraged basis. The income it generates for distribution to its shareholders comes from the difference between the yield on its mortgage assets and the costs of borrowing. (Source: “Q3 2024 Earnings Presentation,” Orchid Island Capital Inc, October 25, 2024.)
The mREIT’s portfolio is made up entirely of highly liquid agency fixed-rate, pass-through securities, interest-only securities, and principal-only securities.
September interest rate cuts by the Federal Reserve had an immediate impact on the company’s funding costs, with its interest expense for September down roughly 30 basis points from August.
As of September 30, 2024, Orchid Island had outstanding repurchase obligations of approximately $5.23 billion with a net weighted average borrowing rate of 5.24%.
Q3 Net Income Swings to $0.24
For the third quarter ended September 30, Orchid Island reported net income of $17.3 million, or $0.24 per share, compared with a net loss of $80.1, or a loss of $0.09 per share, in the same prior-year period. (Source: “Orchid Island Capital Announces Third Quarter 2024 Results,” October 24, 2024.)
Interest income on the portfolio in the third quarter was up 34% at $6.6 million. Minus interest expense, the mREIT’s total net interest income swung from a loss of $8.6 million to income of $340,000.
The yield on Orchid Island Capital’s average agency RMBS increased from 5.05% in the second quarter of 2024 to 5.43% for the third quarter of 2024.
Orchid ended the quarter in a strong liquidity position with $326.7 million in cash and cash equivalents.
Orchid Island Capital Stock Maintains Monthly Dividend of $0.12
As a REIT, Orchid Island Capital has to legally distribute at least 90% of its taxable income to shareholders in the form of a dividend.
Orchid Island Capital stock has a monthly dividend rate of $0.12 per share, or $1.44 on an annual basis, for a forward yield of 18.34%. (Source: “Dividend History,” Orchid Island Capital Inc, last accessed November 20, 2024.)
Double-Digit Upside with Orchid Island Capital Stock?
The chart below is a great example of how investors responded to the Federal Reserve announcing it was done cutting interest rates, which it did back in early November 2023. Investor optimism was further buoyed after the Fed said it was going to start reducing interest rates. It has done so twice since September.
Since the start of November 2023, Orchid Island Capital stock has returned total profits of 47%. That’s adjusted for reinvested dividends. Had a shareholder elected to take the monthly dividend and run, the return slips to 23.65%.
While ORC stock has traded in a relatively tight range over the last number of months, it is still up 6.4% year to date, having rallied 25% on an annual basis. Much of those gains came on the heels of the Fed’s November 2023 announcement.
Fortunately, Wall Street expects Orchid Island Capital stock to break to the upside over the coming quarters, with analysts providing a 12-month share price target of $9.50. At current prices, this points to potential gains of 22.5%. Should Orchid Island Capital stock hit that target, it will be trading at its highest level since August 2022.
Chart courtesy of StockCharts.com
The Lowdown on Orchid Island Capital Stock
Orchid Island Capital is a financially robust mortgage REIT with a growing portfolio of RMBS.
While the long-anticipated interest rate cuts from the Fed are having the desired effect on inflation, this doesn’t mean they will result in an extended easing cycle or go at the pace many on Wall Street expect.
That’s because the U.S. economy is doing so well, and it’s not expected to contract in the near term. This will probably lead to smaller and less frequent interest rate cuts over the coming months.
On the plus side, Orchid Island’s agency securities are generally fixed-rate 30-year and 15-year securities. The mREIT’s hedges, meanwhile, have a longer duration bias, which protects the portfolio against an unanticipated rise in longer-term rates.
This helps reduce the interest-rate sensitivity of the portfolio. That said, lower interest rates are still obviously good for Orchid Island, because it can borrow money at much better terms.
And total returns should improve if the Fed continues its easing monetary policy. Even if it doesn’t, the company’s total returns are still attractive. All of this bodes well for Orchid Island Capital stock’s reliable monthly dividend.
It’s also good news for the 156 institutions that hold a position in Orchid Island Capital stock. Roughly 13.5% of all outstanding shares are held by BlackRock, Inc. (8.6% stake) and The Vanguard Group (4.8%).
