One mREIT to Put on Your Buy List This Week

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Armour Residential (NYSE: ARR) recently announced its preliminary estimated results for the fourth quarter and the year 2012 as well as a new preferred stock offering. In this article, I will discuss Armour Residential as an investment in relation to the estimated fourth quarter results and latest stock offering.

Preliminary Estimated Results

Armour Residential announced the preliminary estimated results and select financial data for the fourth quarter. The company estimates that it will earn taxable refit income per share for the quarter and for the year ended Dec. 31, 2012, which would be sufficient to cover the dividends paid of $0.27 and $1.20 per share for the quarter and for the year respectively. GAAP earnings for the fourth quarter are expected to be in the range of $114-$117 million, working out to an EPS in the range of $0.36 to $0.38 per diluted common share.

Armour's book value as of Dec. 31, 2012 works out to $7.28 to $7.30 per diluted common share. As of this date, there were 309,013,984 common shares and 2,005,611 series A preferred shares outstanding. As at Feb. 12, there were 309,045,797 common shares, 2,180,572 series A preferred shares and 5,400,000 series B preferred shares outstanding.

Armour estimates that its current book value shareholders' equity is between $6.70 and $6.76 per diluted common share. The preliminary estimated GAAP earnings and book value, as well as taxable REIT income, are subject to revision on the finalizing of the accounts. These preliminary estimates could differ because of factors such as additional adjustments in the calculation of financial results, or portfolio values and accounting changes required by GAAP.

Armour also announced  that it has priced an underwritten public offering of 65,000,000 shares of common stock. The underwriters have been granted a 30-day option to purchase up to 9,750,000 additional shares of common stock and are offering the shares at prevailing market prices or from time to time through the NYSE, the over-the-counter market, negotiated transactions or otherwise. The company intends to use the net proceeds of the offering for the acquisition of additional agency securities depending on market conditions, as well as for general corporate purposes. The offer is priced at $6.84 a share against the current market price of around $6.55 a share.

What the Analysts Say

Deutsche Bank has downgraded Armour Residential from buy to hold with a price target of $6.75 (down from $8.30). The bank has commented as follows: "On February 13, ARR reported an estimated current bvps range of $6.70 and $6.76, down 13% from the last reported bvps of $7.77 as at 30 September. Given the book value range and yesterday’s equity offering, we estimate pro forma post-deal book value of $6.73 per share. As a result of the bvps decline and a reduction in our bv premium from 5% to 0%, we are reducing our target to $6.75 per share from $8.30 per share. Given our new target relative to the current valuation, we are reducing our rating to hold." 

ARR has priced a secondary offering of 65 million shares at $6.84 per share, raising their net proceeds estimate to roughly $440 million. "Given currently available spreads versus the existing portfolio roes, we believe the new capital can be deployed at slightly accretive levels assuming roughly 9.0X leverage," points out Deutsche Bank. BOFA/Merrill Lynch has also downgraded Armour Residential from buy to neutral.

About the Latest Stock Offering

Like Armour's other offerings, a monthly dividend will be paid, and there will be a slightly larger first dividend payment on ARR-B of $0.2461 per share (instead of the typical $0.1640625). I believe ARR-B has greater relative value in comparison to ARR-A, which was the earlier preferred stock. Both of them trade at a current yield of just over 8%, but ARR-B trades below par while ARR-A trades at a premium that will take some time to recoup. ARR-B offers an attractive monthly coupon rate that compares favorably with other agency mREIT preferred stock available in the market.  If you are comfortable with the risks of the mREIT industry and would like the stable dividend yield of a preferred, ARR-B is a good income investment opportunity.

Other mREIT Stocks

Realty Income (NYSE: O) has shown some good numbers in its most recent quarter, including a 16% increase in the top line to $130 million and fund generation from operations (defined as net profit with depreciation and amortization added back) growing by 6%. The guidance for 2013 projects an adjusted fund generation from operations of between $2.33-$2.39 per share compared to $2.06 per share for 2012. Occupancy is at an  impressive 97% on the over 3,250 properties that the company operates.

The tenant roster has plenty of famous names but none that takes up too much space. FedEx is post-merger Realty Income's top renter, but the famous logistics company accounts for just over 5% of its total portfolio rental revenue. The rest of the list consists of the likes of L.A. Fitness, AMC Theaters, CVS, and BJ's Wholesale Club. The company has also acquired and absorbed American Realty Capital Trust, a smaller REIT, and this is the reason the company raised its AFFO projection. It anticipates that the new acquisition will add $0.20-$0.22 per share. However, you should note that the dividend yield at around 4.9% is low compared to its peers.

Two Harbors Investment (NYSE: TWO) has an attractive portfolio, which is very well diversified with high yielding non-agency residential mortgage backed securities making up 19% of the portfolio and providing the company with an advantage over its competitors. As of the end of the fourth quarter, the company’s agency MBS portfolio yielded 2.9% in comparison with 9.5% on its non-agency MBS portfolio. 

It is now acquiring residential properties which will be leased out for income. The company has an attractive valuation compared to most of its peers in the US and is currently trading at an 8% premium to its book value, while American Capital Agency and MFA Financial are trading at a 3% and 28% premium to their respective book values. In contrast, Annaly Capital Management is trading at a 4% discount to its book value. The dividend yield is highly attractive, and the stock is recommended for income investors comfortable with mREIT risk

Conclusion

I have often said that mREIT stocks are not ideal long-term income investments. But, they do offer some of the most attractive yield investments in the market and will continue to do so in a low interest rate regime which, I believe, should last through 2014 at the very least. There is no reason why investors should not take advantage of this. I recommend buying Armour Residential. At the same time, investors should keep an eye on interest rate developments.


jordobivona has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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