How to play mREITs?
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Ben Bernanke recently cheered the market when it was announced that the interest rates in the US would be kept low. The businesses that cheered the most were market liquidity dependent. By keeping the low interest rate environment, the liquidity in the market would allow businesses like mREITs to prosper, and hopefully bring the industry back to its full health.
Mortgage REITs buy mortgages from the market, package them and sell them to buyers. The business model is highly leveraged as the companies need to borrow money from lenders. Mortgage REITs then sell their mortgages at higher interest rates, and that is how the companies make money. The risk of investing in such companies after the housing bubble collapse is visible to all. Since the real estate market is showing signs of recovery, coupled with a low interest rate environment, investors now have a chance to catch beaten up stocks.
Penny Mac (NYSE: PMT) is an mREIT that has increased from $14.60 to $21.54 in a matter of 9 months, giving returns of nearly 50%. The company is involved in packaging the mortgages and selling them in the form of securities. Being a step ahead of its competitors Annaly Capital (NYSE: NLY) and Two Harbors (NYSE: TWO), Penny Mac is also involved in selling mortgages directly to customers. This adds to market share available for PMT.
The recovering industry?
The mortgage refinancing industry is enjoying a good run. The volume of refinanced mortgages in Q1FY2011 stood at $240 billion which increased to $290 billion in a Q1FY2012. It was reported recently that the Refinance index of Mortgage Bankers Association had hit a record high in July, since April 2009, and low interest rates are to be thanked for it. Though it would not be fair to compare these numbers to pre-crisis days, as consumers now are far more stringent with their spending budgets, it does however indicate that there is a growing need of refinancing and mREITs could be perhaps, be invested in again.
Raising more Capital
Penny Mac in its recent statement announced that it will be floating 12 million shares in the open market. The capital raised would be primarily used to increase mortgage securities, as well as the company’s exposure to the refinancing market. The net proceeds are expected to be used to buy a portfolio of residential mortgages. This would boost the company’s potential earnings, making the stock attractive to investors. This highlights the vision of the company, and how it sees growth opportunities in the times of recovery.
The competition
Two Harbors has a skyrocketing debt/equity ratio of 4.87 which is significantly higher than Penny Mac’s 0.002. This number makes Two Harbors highly leveraged, and unsafe primarily due to debt problems. Chimera (NYSE: CIM) which is a direct subsidiary of Annaly Capital Management, and a competitor of Penny Mac Trust, made headlines when the company issued a press release stating that the profits of the past 3 years were $411 million lower than reported. The company personnel are under scrutiny, as the managers may have tried to hide their losses. The prime purpose of owning Chimera is to allow Annaly Capital Management to invest in riskier investments, which are not guaranteed by Freddy Mac or Fannie Mae. Annaly Capital has an even worse debt/equity ratio of 6.09 which makes the parent company also a risky bet.
Fundamentals
The company with a market capitalization of $893 million trades at 7.51x P/E. The PEG stands at 0.3 and both the numbers make the stock appear quite undervalued. Penny Mac has a huge dividend yield of 10.21% and a payout ratio of 75.31%. The net profit margin stands at 46.21% and the EPS for the next 5 years is expected to grow at 25% annually. The fundamentals are nothing short of spectacular.
Conclusion
Though the numbers indicate that the real estate investment industry is recovering, is still does not make the industry risk free. Any investor willing to invest in the industry could take the opportunity to look at Penny Mac Trust. The company is looking to expand, and is fundamentally spectacular, making the stock a good investment option.
PiyushArora has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
