Annaly Capital Management (NLY +0.47%) currently has an eye-popping dividend yield of nearly 17%. While that big-time payout might be alluring, it likely won't stay at that level for much longer.
Driving that view is the mortgage REIT's weakening financial results. They led the company's management team to warn investors that they expect the dividend to cut the dividend again this year.
Telegraphing the next move
Annaly recently reported its fourth-quarter and full-year results. The REIT generated $0.89 per share of earnings available for distribution (EAD). That was $0.01 per share more than analysts expected. It was also enough to cover its $0.88 per share dividend payment.
NYSE: NLY
Key Data Points
However, EAD was down $0.17 per share from the prior quarter. CEO David Finkelstein noted on the quarterly conference call discussing those results, "While we generated EAD that covered our dividend this quarter, we witnessed the moderation discussed in recent quarters." However, the company expects "some further pressure on EAD."
Here's what will happen as a result, according to the CEO:
We expect to reduce our quarterly dividend in the first quarter of 2023 to a level closer to Annaly's historical yield on book value of 11% to 12%, which compares to the approximately 16% yield on book we are paying today. We believe this decision allows us to appropriately manage the portfolio within conservative risk parameters while also delivering a more sustainable yield that is competitive with the peer set and broader fixed income benchmarks, which has always been our objective.
With a book value of $20.79 per share at the end of the quarter, this outlook implies Annaly will reduce its quarterly dividend to between $0.57 and $0.62 per share. That's a 30% to 35% reduction from the current level.
Continuing to go in the wrong direction
The upcoming dividend cut won't be Annaly's first. The mortgage REIT's payout has been on a downward trajectory since the financial crisis:
NLY Dividend data by YCharts
That's due to the impact interest rates have on its business. As a mortgage REIT, Annaly primarily makes money on the spread between where it can borrow money and the interest paid on the residential mortgage-backed securities (MBS) it holds. This spread, known as the net interest margin, moves as interest rates change. With interest rates rising over the past year, Annaly's borrowing costs have increased. Its average cost of funds in the fourth quarter was 2.11%, up from 1.54% in the third quarter. While the company's average yield on interest-earning assets also increased, its net interest margin has declined. That means it's making less money on the spread, giving it less income to pay shareholders via the dividend.
Not a good sign
On the one hand, Annaly's reset dividend will still look attractive since it will remain in the double digits. That might have yield-hungry investors thinking it's a worthwhile option.
However, companies that cut their dividends are notorious underperformers. According to data from Ned Davis Research and Hartford Funds, dividend cutters and eliminators have performed atrociously over the last 50 years. They've produced a negative average annualized total return of 0.5%. For comparison, the S&P 500 has provided an 8.2% average annual total return during that period. Meanwhile, companies that initiate and grow dividends have performed even better, producing a 10.7% average annual total return.
We've seen similar underperformance from Annaly over the last decade. Despite paying a massive yield, it has only produced a 1.6% average annual return due to its steadily sinking stock price. That has woefully underperformed the S&P 500's 12.6% average annual total return during that timeframe.
Steer clear of this dividend stock
Annaly expects to reduce its dividend once again. While the REIT will still offer a tempting yield, income investors are better off avoiding this stock. That big payout likely won't be enough to offset the continual slide in its stock price. As a result, Annaly appears poised to continue its woeful underperformance.
