Dynex Capital: Growth Investors Can Find It Attractive

Summary

Dynex Capital is slowly shifting to only agency mortgage-backed securities making the business model more stable and secure.

With the rise of house prices and the economic recovery, DX had a good 2021 which is likely to continue in 2022.

DX is a dividend nightmare with numerous cuts and no increases in the previous years.

JARAMA/iStock via Getty Images Investment thesis

Dynex Capital, Inc. ( DX ) operates in the cyclical REIT business but the cycle is turning in their favor after the pandemic. Housing prices are on the rise and the U.S economy is moderately growing. However, the interest rates are very likely to rise in 2022 tightening DX’s profit margin. The stock can be a target for growth investors because it is undervalued but the future growth potential seems limited at the moment. For income-seeking investors, the stock is a big no with 7 dividend cuts in the last 10 years. Business Model

Dynex Capital is a mortgage REIT (mREIT) and it provides financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS) and earning income from the interest on these investments. The vast majority of their income comes from Agency backed assets and only 2% of their investment portfolio is in Non-Agency Commercial Mortgage-Backed Security (CMBS). The company uses leverage to borrow capital to be able to relend it on higher interest. Financials & Earnings

Q3 results

DX reported good 3rd quarter earnings. Their net income was $0.35 per common share, the EPS outperformed the previous estimate by 10% (EPS actual: $0.54 per share; EPS Previous Estimate: $0.49) Book value per common share was $18.42 in Q3, slightly down compared to Q2 results of $18.75. The company continued growth in equity capital by raising $27.9 million through at-the-market (“ATM”) offerings of common stock, bringing year-to-date capital raised to $224.4 million. CEO of Dynex Capital is optimistic about the long term results of the company and the dividend: “We believe the current environment remains favorable for us to generate solid long-term returns. We are pleased to once again have generated returns in excess of our dividend in the quarter,” stated Bryon Boston, Chief Executive Officer. I agree with the growth part and the favorable environment, because of the economy reopening, house price rises. However, in terms of the CEO’s self-confidence in dividends, I see that from a different perspective. (More on that later in the dividend section.)

The company maintains a flexible portfolio, substantial liquidity, and a significant capacity to increase leverage. The management believes they remain positioned to generate returns that exceed the dividend, which also provides a capital cushion while generating solid long-term returns. DX has been moving from commercial mortgage-backed security and from other riskier assets to safer Agency RMBSs in the last year. As of September 30, 2021, 89% of their capital is allocated to Agency RMBS. Valuation

Black Friday and Cyber Monday’s market drop made DX’s stock a bit more attractive and pushed it to a negative YTD return of -7.5%. That also means the dividend yield skyrocketed to an almost 9.5% yield. DX’s forward Non-GAAP P/E ratio seems appealing with 8.43 compared to the sector median of 11.00. But if we take a look around mREITs we can see that DX is fairly valued among them. MFA Financial, Inc. ( MFA ) mainly operates in the residential mortgage securities sector and has a forward P/E ratio of 7.76. New York Mortgage Trust, Inc. ( NYMT ) also invests in residential houses, single and multi-family homes and the company has a forward P/E ratio of 8.49.

When evaluating DX stock’s intrinsic value, we see an undervalued stock. For the calculations, I used Graham’s DCF model . For the last 4 quarters, the official EPS (TTM) was $4.71 but that is a bit unrealistic for future calculations as this high number was mainly because of Q1 2021 exceptionally good results. For the calculations, I used a more realistic EPS number, $2.5. Finviz estimates that in 2022 DX’s EPS will be $1.94. To the expected growth rate, I added a moderate 1%. That is because the upcoming growth of mortgages could be offset by the expected interest rate rise in 2022 and 2023. Finviz analysts also calculated a forward 5-year EPS growth which is -3.05% for DX. Put all this data together and we can have an intrinsic value for DX stock between $45-50. If we use Finviz’s forward 1-year EPS number, the intrinsic value for DX stock is between $35-37. […]

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