BKCC - 2023: Beat Bear Market With BlackRock Capital

Summary

• In 2023, BlackRock Capital Investment Corporation is likely to beat the S&P 500 due to its lofty dividend yield and solid price growth prospects.
• High-interest rates and investment portfolio growth are likely to boost BKCC's earnings in 2023, while a shift toward secured lending and selling non-core assets could lower its portfolio volatility.
• In addition to strong industry fundamentals, its shares are expected to benefit from cheap valuations in 2023.

After beating S&P 500 by a wide percentage in 2022's bear market, BlackRock Capital Investment Corporation ( BKCC ) can help investors ride out the recession smoothly as its business model is benefitting from high-interest rates along with increasing demand for alternative financing. Its portfolio yields and earnings are on track to reach new record levels in 2023, setting it in a position to raise dividends and sustain its double-digit dividend yield. Moreover, cheap valuations and improving industry fundamentals could support its share price performance throughout 2023.

Bear Market Outlook and BDCs

The 2023 U.S. stock market outlook isn't promising for value and growth investors, with most forecasts pointing to more challenges for the broader market index. JPMorgan expects the S&P 500 Index (JPM) to end 2023 slightly up from current levels, while Morgan Stanley (MS) predicts negative price returns. In addition to the recession and high-interest rates, corporate profits are the biggest headwind for the stock market performance. Analysts from Morgan Stanley and JP Morgan have recently lowered their 2023 earnings forecasts to $205 and $195 respectively, indicating one of the largest drops in two decades. Morgan Stanley analyst Wilson predicts a similar earnings recession to 2008-2009, but he also hints that the market does not price such an outcome until it actually occurs. In other words, the stock market has not yet realized how a steep profit drop will impact sentiments. The strategist expects stocks will likely sink in the following quarters when corporate profits actually fall.

In order to avoid this troublesome situation, it's wise to invest in stocks that can weather headwinds and outperform the broader market. Historically, high-yield investing is one of the most successful strategies during bear markets and recessions. For instance, the S&P 500 High Dividend Index generated positive returns in 2022’s bear market compared to the S&P 500’s negative total returns of around 18%. Despite that, the current business environment requires investors to be cautious when choosing stocks since many high-yielding sectors, such as real estate, struggle to sustain their dividend growth. Meanwhile, the business development industry is one of the areas that has been thriving despite tough economic conditions since BDCs are benefiting from high rates.

The majority of BDCs borrow money at fixed rates while they invest that money on a floating-rate basis. Thus, their net investment income has grown at a rapid pace over the past few quarters due to Fed's aggressive rate hike policy. BDCs have also been witnessing higher demand for alternative financing due to traditional lenders' restrictions on middle-market private companies and a decline in venture investments. Furthermore, most BDCs offer double-digit dividend yields since they must return 90% of their earnings to shareholders, a key element that enables BDCs to outperform S&P 500 returns in bear markets. You can read a detailed overview of BDCs outlook in my article " BIZD: Another Solid Year Is Ahead ."

BlackRock Capital’s Double Digit Yield is Safe

BlackRock Capital Investment Corporation appears to be one of the safest business development stocks to own in 2023. In 2022, the company's shares fell less than the broader market index, and its double-digit dividend yield aided in compensating for the decline in share price. As a result, the company's total returns remained flat compared to the S&P 500's negative 18% total return. In 2023, BKCC's dividends are not only safe but the company also appears well-positioned to increase them due to its robust earnings growth power.

As shown in the chart above, BlackRock's sequential increase in investment income and net investment income in the last three quarters demonstrates that its fundamentals have been improving quarter over quarter . Its latest quarterly earnings per share of $0.10 offered a complete cover to its dividend payment of $0.10 per share. Since earnings are expected to exceed dividends in 2023, a dividend hike is highly likely. Wall Street estimates and market fundamentals suggest that BlackRock is likely to earn $0.43 per share or even more in 2023.

Multiple factors contribute to the company's earnings growth potential, including high-interest rates, a growing investment portfolio, and improved portfolio yields. In addition, factors such as a shift in portfolio management strategy, the floating nature of the portfolio, and a high percentage of first-lien loans could also play a crucial role in generating sustainable earnings growth in the long run. In order to reduce the risk associated with portfolio holdings, BlackRock aims to increase the percentage of first-lien investments above 80% of the overall portfolio. At the end of the third quarter, 77% of its debt investments were first liens, up from 74% at the end of 2021 and 34% at the end of 2019. Junior capital was also reduced to just around 6% of the entire portfolio from 43% in 2019. The company has also eliminated some non-core assets in 2022, helping it raise cash for investment in growth opportunities. Also, in an effort to reduce portfolio volatility, it reduced equity stakes to 2% of the portfolio from 7% last year. On the other hand, the company has been growing its investment portfolio quarter over quarter by offering senior secured loans to high-quality companies. Furthermore, there is sufficient liquidity in the company's balance sheet to support investment activities. At the end of the third quarter, the company's net leverage was 0.71 times, which is well below compared to the industry average of over 1x.

BlackRock’s Share Price Could Top S&P 500 in 2023

In 2022, BlackRock's shares fell significantly less than the S&P 500 index due to its strong financial and operational performance. Stock price volatility was also lowered by investors' increasing confidence in its double-digit dividend yield. BlackRock's share price may generate positive returns in 2023 and outperform the broader market due to a number of factors. First, the broader market is unlikely to fall as much as it did in 2022, which means that BKCC's stock will have a greater level of support from external trends than the year before. In addition, BKCC's stock is likely to benefit from its earnings quality, as well as potential dividend increases. In addition, cheap valuations and a promising financial outlook could also support its stock price growth.

Quant Data Signal a Buying Opportunity

The Seeking Alpha quant system rated BlackRock as a buy with a quant score of 4 out of 5. The stock received an A plus grade on valuation, which indicates that it is trading at attractive levels compared to the sector median. As an example, its shares are trading around only nine times earnings while its price-to-book ratio is hovering at 36% below the sector median. In addition, the company’s current stock price of $3.62 is also well below its net asset value of $4.56 per share. Meanwhile, the B plus grade on profitability and the C grade on revision also indicate strong financial prospects. Based on the quant analysis , the company is ranked 15th out of 94 stocks in the industry.

In Conclusion

Investing in stocks like BlackRock is prudent because they perform well both in bullish and bearish market conditions. Even if the stock market experiences low to no growth in 2023, I believe BlackRock Capital Investment Corporation could achieve solid total returns due to its earnings growth power, high dividend yield, cheap valuations, and positive industry dynamics. Additionally, these properties are likely to contribute to strong upside momentum during bullish market conditions. The risk of poor performance is low because the BlackRock Capital Investment Corporation's debt portfolio is composed of secured loans while its low leverage and strong cash position would enable it to invest in growth opportunities.

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