Ladder equity: 7% return, inflation-busting machine (NYSE: LADR)
A general rule for investors, whether professional or retail, is to generate a positive rate of return relative to their cost of capital. For example, an investor may choose to invest in stocks whose average rate of long-term return, rather than aggressively paying off their low-interest mortgage ahead of schedule.
Perhaps just as important as the cost of capital is inflation, which has taken center stage in recent months. While inflation tended to fall to 4.9% in April, it is still high compared to recent years. This brings me to Ladder Capital (NYSE: LADR), which pays a well-hedged high dividend yield that can be a good choice for income investors who want to stay ahead of the game, so let’s get started.
LADR: a machine to break inflation
Ladder Capital is a commercial mortgage REIT that has made $44 billion worth of investments since its inception in 2008, making loans in 475 cities in 48 states.
It focuses on generating senior secured loans secured by high quality properties and is internally managed, resulting in a better alignment of interests between management and shareholders. Indeed, management compensation is not directly linked to the size of assets under management, as in the case of external managers.
Currently, LADR has a diversified investment portfolio of $6 billion, consisting of $3.9 billion of primarily secured first mortgages (98%) with a focus on the middle market, $663 million in CRE securities, 86% of which are AAA rated. or a backed agency, and $1.1 billion of physical real estate. Unlike its peers who focus on riskier development properties, LADR avoids this space with no construction loans on its balance sheet.
Notably, the real estate portfolio is 100% leased, with 67% of net rental properties leased to high quality tenants such as Bank of America (BAC), Dollar General (DG), Sam’s Club (WMT), Tractor Supply Co .(TSCO) and Walgreens (WBA).
LADR is showing strong earnings momentum as its disciplined deployment of capital has led to successive EPS growth every quarter since the start of 2021. This has continued in the last reported quarter, with distributable EPS reaching 0.25 $, more than fully covering the $0.20 quarterly dividend rate.
This was due to a healthy credit environment, with $732 million in loans originated during the quarter. LADR also sees a fair amount of repeat business, as 25% of those originations were made for repeat Ladder borrowers. Additionally, LADR is moving into the more in-demand multi-family space, as this segment accounted for 80% of its origins in the last quarter.
Looking ahead, the LADR appears to be well positioned for interest rate hikes, given that the Fed has signaled further half-point hikes this year. This takes into account that 95% of its on-balance sheet loans are variable rate.
As shown below, this results in an increase in EPS with up to $0.41 of additional EPS based on a 200 basis point rate increase. It also maintains a balance sheet well positioned to fund opportunistic growth, with $700 million in cash and adjusted leverage of 1.6x net of cash.
Risks for LADR include the potential for a recession, which could impact the health of its borrowers. Management downplayed risks specific to LADR, as debt yields tend to be more stable, as noted during the Q&A section of the recent conference call:
Q: In terms of the economic outlook, there seems to be a decent chance of a recession in the next 18 months, for example. Have you adapted asset management policies, strengthened supervision, strengthened dialogue with borrowers? Overall, how do you think the company would be positioned?
A: We are aware of this and we believe this will happen. The word recession must have some degree attached to it. We don’t think at this point we were expecting a severe recession, which means if you’re under 45 you probably don’t know what I’m talking about. Unless you’ve read a lot of books, but a recession isn’t necessarily a bad thing.
If it’s a normal part of an economic cycle and I think it’s fine if growth contracts or goes negative for a few quarters, that’s not a big deal. I am not thinking of this recession which may be an echo of 2008 or an echo of the pandemic slowdown that we have seen. So I think this one was really around 1998, 1999 is the one I would watch. So I don’t think a recession is something to be feared, but yes, it is something to be taken care of. I think equity returns in a recession aren’t as good, but debt returns tend to do well.
Meanwhile, I consider the current LADR stock price of $11.59 to reflect negative investor sentiment. As shown below, this translates to a price-to-book ratio of 0.98x, well below the pre-pandemic range of around 1.3x. Analysts on the sell side have a strong buy consensus rating, with an average price target of $13.70. This equates to a potential total return of 25% including dividends.
Key takeaway for investors
LADR is a well-managed commercial mortgage REIT that should benefit from rising interest rates and is positioned for opportunistic growth. It also shows decent EPS momentum and the dividend is now largely covered by earnings. Given these factors, along with a stock price that reflects negative investor sentiment, I think LADR offers decent value at the current level.