Even the Market Gets the Blues
Is it me or does this earnings season seem more volatile for some stocks than usual? Granted, as an inveterate worrier, I tend to fixate on bad news while being too quick to dismiss good news.
Still, I can’t help noticing that financial results and guidance that would have been accepted by the market with greater equanimity in previous quarters is causing tumult for certain stocks this time around.
Even in an era where programmatic trading dominates market volume, I can’t help wondering if the market remains susceptible to seasonal affective disorder.
While investors can literally trade from anywhere, the financial markets are still centered around New York. And the city’s concrete canyons can cast a pall over even the sunniest disposition as the days get shorter and the nights get longer.
Years ago, the Federal Reserve Bank of Atlanta actually did a study that suggested seasonal stock-market patterns reflect people’s depressive tendencies. The authors of the study noted that these patterns persisted even when studying regions of the world where winter occurs during our summer.
One of the ways depression can manifest in market behavior is heightened risk aversion. That may account for some of the punishing selloffs we’ve seen in recent weeks.
Perhaps our financial markets should be based out of San Diego instead.
Nevertheless, there’s been plenty of good news too. And overall, the broad market continues to head higher.
NRZ Residential Investment (NYSE: NRZ) saw its share price jump higher on a strong earnings beat, for its sixth consecutive upside surprise.
Core earnings grew 25% year over year, to $0.64 per share, as the real estate investment trust (REIT) continued to provide servicing to mortgage holders while helping them clean up troubled debts.
During the quarter, NRZ acquired the rights to service $110 billion of non-agency mortgages for $400 million from Ocwen Financial Corp.
Ordinarily, I’m not a big fan of mortgage REITs, which use leverage to amplify the yields of their investment portfolios.
However, NRZ is a bit different than its peers. Rather than focus on investing in residential mortgage-backed securities (RMBS), its portfolio is concentrated on investing in the rights to service these loans.
Therefore, this fee-based business is more transactional, with less direct exposure to the creditworthiness of the borrowers.
Even so, NRZ is an opportunistic investor that seeks out dislocations between the value of underlying assets and their associated securities. For instance, that means its bond portfolio focuses on mortgages that aren’t backed by federal agency guarantees.
In other words, NRZ tries to profit from fixing troubled situations. That’s how it generates income with the prospect for capital appreciation.
Obviously, at this stage of the cycle, the opportunities to clean up problem credits from the foreclosure crisis are dwindling.
But NRZ’s external manager, the hedge fund Fortress Investment Group, is a shrewd player that knows how to find new opportunities with an eye toward adapting to a rising-rate environment. For instance, the firm has recently started investing in consumer loans.
Nevertheless, it will be important to keep a close eye on how NRZ’s portfolio evolves.
While this is shaping up to be a strong year for the REIT, core earnings are expected to decline 17% next year. Even the most bullish forecast for next year’s earnings is more than 9% below where NRZ is tracking this year.
However, those expectations could change materially as NRZ’s portfolio changes.
Fortunately, the quarterly dividend remains well covered by core earnings, by about 1.3 times in the most recent quarter. That makes the double-digit yield less worrisome than it would be in other situations. NRZ is a buy.
Normally, I wouldn’t touch an MLP with a 16% yield with a 10-foot pole.
In reviewing this service’s portfolio holdings, I had initially assumed that Sanchez Midstream Partners LP (NYSE: SNMP) was the one high yielder that would be an obvious candidate for cutting.
First, a yield in the mid-teens makes it too expensive for SNMP to tap the equity market for funding, which is something that all MLPs have to do eventually.
More worrisome is the fact that its sponsor, Sanchez Energy Corp. (NYSE: SN), carries such a disturbing level of debt—about six times its market cap—that it had to get really creative when financing this year’s potentially game-changing acquisition.
SNMP is no slouch in the leverage department either, though at least its debt only slightly exceeds its market cap.
When you shoulder that much debt, you always need more time. In this case, time for production growth and rising commodity prices to turn things around.
But in taking a closer look at the Sanchez complex, I’m willing to give this special situation a bit more time to work out.
Earlier this year, the sponsor nearly doubled its footprint in the Eagle Ford shale play by acquiring significant acreage from Anadarko Petroleum Corp. alongside joint-venture partner Blackstone Group LP (NYSE: BX).
While the latter’s imprimatur counts for a lot, it’s the potential production growth from this newly acquired acreage that has us sticking around to see if Sanchez can deliver.
The sponsor has been aggressively hedging future production each time oil prices rise above $50 per barrel, which should help ensure it’s still economic to pull hydrocarbons out of the ground even at lower prices.
At the very least, we want to see how both entities performed during the third quarter, and whether actual production remains on track with previous guidance. SNMP is a hold.
As some of you may have noticed, Igor is no longer with this service and has decided to pursue other opportunities instead.
Igor is an insightful analyst, a brilliant writer, and a fearless investor. I’ll miss bouncing ideas off of him, as well as his occasional snark—well, maybe it was more than occasional.
In addition to leading Utility Forecaster, I’ve previously helped run Canadian Edge and MLP Profits, two of the three newsletters that were merged into this one. So in a sense, this is a homecoming.
As part of this transition, I recently sat down with Investing Daily’s director of portfolio strategy to consider how to deal with Income Millionaire’s expansive portfolio.
With nearly 40 holdings, the portfolio is a bit unwieldy, to say the least. Consequently, we decided to cut any holdings that yield less than 4%.
Our rationale is that most subscribers are in this for current income. And we can’t really call ourselves Income Millionaire when some of our holdings yield less than 2%.
Although many of the lower yielders are positioned for strong dividend growth, it could still take years for their effective yields to be meaningful if purchased at current levels.
To see which securities are being removed from the portfolio, please review the portfolio table. If you have questions about any of these names, then I’ll be happy to answer them in Stock Talk.
Aside from above-average yields, we have other ideas for how to generate current income that we’ll reveal in the coming months.
Additionally, we’re considering restoring buy targets to the remaining holdings so that you have some sense of how a stock is trading relative to fair value.