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Monday, January 5,
1998
Redwood Trust Inc.
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Phone: 415-389-7373
Price (1/2/98): $20 3/16
HOW DID IT FIND TROUBLE?
Who is chopping down the beloved Redwood? Hugging this tree has been hazardous
to one's wealth. For a company buying up high quality residential mortgages,
this would seem to be the perfect climate.
Interest rates are low so the homebuilding industry is faring well. The low
rates have also encouraged investors to snap up shares of high-yielding stocks,
like Redwood. So if interest rates are low -- why is Redwood lower?
The demise began in June when Furman Selz analyst Jamie Handwerker cut earnings
estimates after the company warned that interest rate spreads might narrow.
Since Redwood makes money by buying up mortgages with cheaper money, that
thinning spread, the very heart of Redwood's income, was in jeopardy.
The stock, which was trading for $55 then, was hacked for a $7 loss on that
day. Things didn't improve the following quarter, and the shares were whacked
for a $10 hit in September when Handwerker had to sand down estimates once
again.
Redwood's bite proved worse than its bark -- and shareholders have been yelling
Timber! ever since.
BUSINESS DESCRIPTION
Redwood Trust acquires and manages real estate mortgage assets, primarily
single-family real estate properties. As a real estate investment trust,
or REIT, the company does not incur income taxes at the corporate level as
long as it pays out at least 95% of its taxable income to shareholders.
FINANCIAL FACTS
Income Statement
12-month sales: $170.5 million
12-month income: $27.3 million
12-month EPS: $1.90
Profit Margin: 16.0%
Market Cap: $309.3 million
Balance Sheet
Cash: $57.7 million
Total Assets: $3525.3 million
Total Liabilities: $3168.9 million
Long-term Debt: $497.4 million
Ratios
Price-to-earnings: 11.2
Price-to-sales: 1.8
HOW COULD YOU HAVE AVOIDED THIS TROUBLE?
When the going was good, Redwood was able to leverage that optimism.
With the stock selling for what was more than two times book value at its
peak, the company found it beneficial to issue new shares. Four times since
last November the company went to market offering a total of five million
new shares.
Since Redwood took that money and immediately bought more mortgage assets
-- at book value -- it helped the company increase its shareholder equity.
Book value per share rose 47% over that time, all due to the company's ability
to issue new shares when the stock was selling at a premium to book value.
That was the impetus for growth since interest rates in the company's loan
portfolio have remained relatively flat at 6.8%. So, while shares outstanding
rose by more than 50%, the earnings power on the shares easily outpaced the
share growth with net income more than doubling.
So when the company announced that the spread was narrowing, investors had
good reason to run from the forest. The continued weakness would take away
the stock offering leverage the company used to have. Once the stock fell
below book value to the low $20's, any stock offerings would now dilute book
value.
Redwood's success of not only cashing in on the spread but also being able
to issue new shares out that would enhance earnings per share was doomed
-- and so was the share price.
WHERE TO FROM HERE?
Just as offering more shares when the stock price was high was in the
shareholders best interest back in the spring, the share buyback announced
in September when the stock price was falling has been equally beneficial.
Granted, the company would rather have it the other way around, but by setting
out to repurchase 745,000 shares, more than half of which have already been
bought back, the company is not only helping its bottom line but may also
be sending out a positive signal to Wall Street.
Then again, last month the company was forced to cut its final 1997 dividend,
which had been $0.60 per share in each of the first three quarters, to $0.35
a share to reflect the expected soft fiscal results. The meager payout is
even lower than the quarterly dividends that Redwood paid out in 1996, when
the stock began the year pretty much where it is today.
Redwood has not been able to garner much investor interest because it specializes
in high quality, low interest, adjustable rate mortgage assets. With a portfolio
averaging an impressive AA+ credit rating, it has not shown the junk bond
sizzle that yield hungry investors often recklessly chase. There is also
the very nature of adjustable rate mortgages, which finds the monthly payments
adjusted to the going interest rates. That has left the company out of the
capital appreciation bandwagon enjoyed by its fixed rate peers in a falling
rate environment -- but will certainly prove to be a comfort the day lending
rates rise again.
-Rick Aristotle Munarriz
([email protected])
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