Mortgage Securities And Hedging Will Secure US Mortgage REIT Stability

Key Takeaways

• Strategic asset sales and stock repurchases under book value may drive future EPS growth by preserving or increasing book value.
  
• Focus on longer-duration hedging and treasury futures aims to enhance earnings stability and improve net margins amid interest rate volatility.
  
• Orchid Island Capital faces asset valuation pressure and increased leverage, navigating volatility and mortgage concerns that may impact earnings and stability.

Catalysts

A specialty finance company, invests in residential mortgage-backed securities (RMBS) in the United States.

• Orchid Island Capital has raised significant capital ($206 million) in Q1 2025 and has used these funds to purchase higher yielding mortgage-backed securities, which could increase future net interest income.
  
• The changes in hedging strategy, with a focus on longer-dated swaps and more treasury futures, could enhance earnings stability and potentially improve net margins in volatile interest rate environments.
  
• The potential for a steeper yield curve driven by economic factors like tariffs and inflation could provide Orchid Island Capital with advantageous conditions for its high coupon, short-duration assets, benefiting revenue and earnings.
  
• Active portfolio management, including strategic asset sales and repurchases of stock below book value, indicates potential future earnings growth as book value is preserved or increased, leading to higher earnings per share (EPS).
  
• With a decrease in refinancing activities and strategic positioning in specified mortgage pools, Orchid Island Capital may see favorable prepayment speeds, supporting stable revenue streams and enhancing net margins.

Orchid Island Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Orchid Island Capital's revenue will grow by 48.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 67.0% today to 57.9% in 3 years time.
• Analysts expect earnings to reach $98.9 million (and earnings per share of $0.79) by about May 2028, up from $35.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.5x on those 2028 earnings, down from 22.3x today. This future PE is greater than the current PE for the US Mortgage REITs industry at 13.4x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.41%, as per the Simply Wall St company report.

Orchid Island Capital Future Earnings Per Share Growth

Risks

• Orchid Island Capital experienced a decrease in book value from $8.09 to $7.94 per share, indicating potential pressure on the company's asset valuations, which could impact earnings.
  
• The leverage ratio increased slightly to 7.8% in Q1, up from 7.3% in the previous quarter, signaling a higher risk exposure that could affect net margins in volatile markets.
  
• The company is navigating high volatility and uncertainty due to tariffs and market dynamics, which could adversely impact revenue generation if economic conditions worsen.
  
• There is a concern about mortgage performance linked to the merger between Rocket Mortgage and Nationstar, potentially leading to increased prepayment speeds that could affect net interest income.
  
• The overall market volatility and interest rate environment, including a shift in swap spreads and pricing pressures, could pose risks to hedging strategies, impacting earnings stability.

Valuation

• The analysts have a consensus price target of $8.0 for Orchid Island Capital based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $170.7 million, earnings will come to $98.9 million, and it would be trading on a PE ratio of 14.5x, assuming you use a discount rate of 11.4%.
  
• Given the current share price of $7.33, the analyst price target of $8.0 is 8.4% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.