ARCC - Ares Capital: A Leading BDC With Strong Performance And High Dividend Yield

2023-11-27 13:05:55 ET

Summary

• Ares Capital is a leading business development company that provides financing solutions for middle-market companies.
• Ares Capital has a diversified portfolio of investments in various sectors, with a weighted average yield of 8.7%.
• Ares Capital outperforms its peers on key metrics such as portfolio yield, NAV/share growth, non-accruing loan ratio, NII payout ratio, earnings growth, profitability, and dividend yield.

Ares Capital (ARCC) is a leading business development company ((BDC)) that provides financing solutions for middle-market companies in various industries. The company is externally managed by a subsidiary of Ares Management Corporation, a global alternative investment manager with over $200 billion of assets under management.

The company's investment objective is to generate both current income and capital appreciation through debt and equity investments. The company invests primarily in first and second-lien senior secured loans, mezzanine debt, and equity securities. The company also can offer one-stop financing solutions to its portfolio companies.

As of September 30, 2023, the company had a diversified portfolio of 352 investments totaling $14.4 billion at fair value, with a weighted average yield of 8.7%. The company's portfolio companies operate in various sectors, such as healthcare, software, business services, consumer products, energy, and aerospace.

Some of the key metrics for analyzing the company's performance are:

• Portfolio Yield: The company's portfolio yield of 8.7% as of September 30, 2023, was slightly lower than the industry average of 9.0%, according to BDC Buzz. This suggests that The company has a more conservative risk profile, focusing on senior secured loans with lower default rates and higher recovery rates. The company's portfolio yield has been relatively stable over the past five years, ranging from 8.4% to 9.4%.
• NAV/Share Trend: The company's net asset value ((NAV)) per share increased by 2.4% in Q3 2023, from $18.06 to $18.49. This was driven by net realized and unrealized gains of $0.89 per share, partially offset by dividends of $0.48 per share. The NAV per share has grown by 9.6% over the past year, and by 25.4% over the past five years, indicating a strong track record of creating shareholder value. The NAV per share growth has outperformed the industry average of 18.9% over the past five years, according to BDC Buzz
• Non-Accruing Loan Ratio: The company's non-accruing loan ratio, which measures the proportion of loans that are not generating interest income due to delay or default, was 1.5% as of September 30, 2023, down from 2.1% as of June 30, 2023. This reflects an improvement in the company's credit quality as it exited or restructured some non-performing investments. According to BDC Buzz, the company's non-accruing loan ratio was lower than the industry average of 2.4% and has been declining steadily from a peak of 4.4% in Q2 2020.
• Net investment income Payout ratio: The company's net investment income ((NII)) payout ratio, which measures the percentage of NII paid out as dividends, was 83.5% in Q3 2023, down from 86.4% in Q2 2023. This indicates that the company's dividend is well covered by its earnings and has room for growth. The company's NII payout ratio has been below 100% for the past 12 quarters and has averaged 82.1% over the past five years. According to BDC Buzz, the company's NII payout ratio was slightly higher than the industry average of 80.9% .
• Growth: Value Research shows that the company's earnings per share ((EPS)) grew by 36.09% in 2020 and by 20.23% in 2019. This shows that the company has increased its income from its investments despite the challenging market conditions caused by the COVID-19 pandemic. The company's revenue grew by 14.6% in Q3 2023 compared to Q3 2022, according to Seeking Alpha. This demonstrates that ARCC has generated more interest and fee income from its portfolio companies.
• Profitability: The company's return on equity ((ROE)) of 6.85% as of September 30, 2023, was higher than the industry average of 5.94%, according to Zacks Investment Research. This means that the company has more efficiently generated profits from its shareholders’ equity. The company's net investment income ((NII)) margin of 57.7% as of September 30, 2023, was also higher than the industry average of 54.4%, according to Seeking Alpha. This indicates that the company has been able to control its operating expenses and maintain a high level of profitability.

• Dividend: The company's dividend yield of 9.88% as of November 22, 2023, was higher than the industry average of 8.67%, according to BDC Buzz. This implies that the company offers its shareholders a more attractive income stream. The company's dividend growth rate of 8.34% per year over the past three years, according to Value Research, was also higher than the industry average of 6.42%, according to BDC Buzz. This shows that the company has increased its dividend payouts consistently, reflecting its confidence in its earnings and cash flow.

According to Seeking Alpha, the stock's mean price target of $20.93 implies a 6.0% upside potential from its current price of $19.74 as of November 22, 2023. The stock has a rating consensus of “Strong Buy,” based on 11 analysts’ opinions .

Based on these comparisons, Ares Capital is a well-managed BDC that outperforms its peers on most key metrics. ARCC has a strong track record of creating shareholder value while maintaining a conservative and diversified portfolio. ARCC also offers a high and growing dividend yield, which makes it an attractive investment option for income-oriented investors.

Risks in this investment

Some of the risks associated with investing in BDCs are:

• Interest rate risk: BDCs use borrowed money to provide financing to other companies at higher rates. As interest rates rise, a BDC’s profit margins could suffer. This could also affect the value of a BDC’s investments, as higher interest rates make debt less attractive and lower its market price.
• Credit risk: The types of companies BDCs invest in are often developing and/or financially distressed. They may be more likely to default on their loans or even go out of business, which could undermine the returns and principal of a BDC. Many of these companies are also private, which means they do not make public disclosures and are difficult to evaluate.
• Market risk: BDCs are subject to the same market risks as other equities, such as changes in investor sentiment, economic conditions, and industry trends. BDCs may also face increased competition from other sources of financing, such as banks, private equity, and venture capital. BDCs may also experience liquidity issues, as their shares may not trade frequently or at fair prices.
• Fee risk: BDCs charge high fees to their investors, which can reduce their net returns. These fees may create conflicts of interest between the BDC managers and the shareholders, as the managers may have an incentive to take on more risk or use more leverage to boost their fees.

BDCs are complex and speculative investments that offer high yields but also entail high risks. Investors should carefully weigh the potential benefits and drawbacks of investing in BDCs, and understand their risk profile, investment strategy, portfolio composition, and fee structure. Investors should also diversify their portfolio and not rely solely on BDCs for income or growth.

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