Tuesday, May 10, 2016

NRZ Analysis

Update 7/18/2016: Having collected a dividend on July 5, I exited NRZ today to free funds for speculation during the July 11-Aug. 19 earnings season. I shall consider re-entering after earnings season is complete. The next ex-dividend date will be in October, allowing a wide window for re-investment, if they is indeed what I decide to do.

Shares rose by 3.8% over 73 days, or a +19% annual rate. The shares plus dividend produced a 7.4% yield on debit for a +27% annual rate.

New Residential Investment Corp. (NRZ), headquartered in New York City, is a real-estate investment trust that invests in residential real estate, primarily through three specialized instruments: 1) Excess Mortgage Servicing Rights (MSRs), 2) Servicer Advances and 3) non-Agency residential mortgage backed securities (RMBS).

As a REIT, New Residential is required pay out at least 90% of its earnings as dividends. The relationship between the dividend and earnings is called the "dividend payout ratio".

NRZ stock has a dividend yield of 13.96% at the current price, for a payout ratio of 91.1%.

I considered NRZ  as a dividend play, a place to park money that I'm unable to trade due to the season's extremely low implied volatility, a condition that shuts out my normal strategy of selling option spreads.

And, Spoiler Alert! I bought NRZ shares on Friday, May 6, and am doing this analysis for the record. If I uncover something that is cringeworthy, of course, I can always exit the position and add chalk up yet another "lesson learned" tick on my blackboard.

[NRZ corporate site]

Supply and Demand Investing
by Clair Edward Leedom III


The Company

New Residential's attraction for me was that it focuses on residential real estate, rather than the commercial real estate that is so common among REITs. It gives me an added degree of diversification.

However, the three instruments listed above that are the backbone of NRZ's strategy sound, in all honesty, like sinister flashbacks to the Crash of 2008-2009 and the Great Recession that followed.

I mean, "mortgage backed securities"? We all know what a harbinger of evil that phrase is.

Or not. There's nothing evil of any of three arrows in NRZ's quiver, as long as they are steered clear of the abuses of that earlier evil age of the late 2000s.

They are used to service mortgage. Banks used to do it. Now specialized companies have taken over the business.

A bank loan is an investment by the bank. In order to raise capital, it sells the right to service that investment to mortgage service companies through an instrument called a mortgage servicing right (MSR), the first item in my list of NRZ's instruments.

The NRZ instrument prefaces MSR with excess. Mortgage servicers, like banks, need to raise capital, so they in turn pass on some of their MSRs to others, such as NRZ, in order to do so.

Mortgage back securities, #3 on the NRZ list, are what they have always been, but more accurately evaluated and priced and better regulated than a decade ago. The abuses in mortgage of lending that were so common in that time -- liar loans, interest-only loads and the like -- have been rung from the system, strengthening the derivatives based motrgage loans.

Item #2 on the list, servicer advances, are advances of money from NRZ to the mortgage servicer that allow the servicer to buy MSR's.

An article on SeekingAlpha about NRZ's strategy can be found here.

It's all very complex, but profit hides in complex terrains.

I've done the long exposition because much of this is new to me -- long-time readers know that I'm a statistics and odds trader, not a fundamentalist. Based on my reading, I'm OK with the concepts. I refuse to let the ghosts and goblins of a past age rule my trading today.

Let's see what the other numbers say.

Analyst enthusiasm is positive, coming down collectively at an 83% enthusiasm rating.

The company reports return on equity of 16%, with debt running at 4.6 times equity, a high level of debt showing that the business is highly leveraged, a risk factor.

Earnings have been profitable in each of the past 12 quarters. Seven quarters have produced upside surprises. The most recent of the downside surprise was the first quarter of the current year.

The earnings yield is 11.87%, compared to a 1.75% yield on 10-year U.S. Treasury notes. The dividend yield is 14.00% annualized at today’s prices.

The "fair" price implied by earnings growth estimates and dividend is $33.40 per share, compared to the market price of $13.14 per share. The market premium is 60.68!% below the implied price.

The stock is selling at 8.4 times earnings and also at a premium to sales. It takes $3.75 in shares to control a dollar in sales.

Institutions own 56% of shares.

NRZ next publishes earnings on Aug. 8. The stock goes ex-dividend in June for a quarterly payout of $0.46 per share.

The Trade

NRZ on average trades 2.7 million shares a day with a one cent difference in the bid/ask spread, making it a very liquid stock

Decision for My Account

I see nothing cringeworthy. I bought shares of NRZ on Friday, May 8, for $12.75 per share.

The stock is under-priced on the PEGY scale, has good returns and a flock of happy analysts following it. The biggest risk is a return to recession, which tends to impact real estate first. Assuming that doesn't happen for awhile, I'll have plenty of time for dividends to lower my basis to give me a good deal of protection.

Exit Strategy

I've set my original exit point according to the one standard deviation mark, using the same options series, the JUN, as I would use for a short-term trade. That sets a lower bound of $11.66, or $1.09 below the entry price.

The share price has dropped on each of the last four ex-dividend dates, a normal behavior for high-dividend plays. The average decline has been $0.52; the maximum, $0.70; and the central tendency, with the outliers eliminated, $0.56.

I shall update the lower bound according to the current standard deviation as the next option series comes into play on the calendar. By my rules, I change option series when the current series falls below 30 days until expiration.

I'll update this post when the exit point changes.

-- Tim Bovee, Portland, Oregon, May 10, 2016

Tradecraft: Playing the odds to build winning stock market trades from options, a description of how I trade, can be read here.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

I can be reached via comments on Private Trader posts or by email at datnillc@gmail.com.


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Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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