BBDC - Barings BDC: Buy This Stock For 12% Dividend Yield

2023-12-07 17:05:56 ET

Summary

• Barings BDC is a business development company that has reported strong quarterly performance and is expected to sustain growth through new investments.
• The company reported an investment income of $70.84 million, up 25.82% compared to $56.31 million in Q3FY23.
• Assuming BBDC chooses to keep paying its $0.26 quarterly dividend, it translates to an annual payout of $1.04 or an 11.97% dividend yield.
• After comparing the forward P/E ratio of 6.49x with the sector median of 9.67x, I think the company is undervalued.

Investment Thesis

Barings BDC Inc ( BBDC ) is a business development company that sources differentiated opportunities across private and public fixed-income, real estate, and specialist equity markets. It has recently reported a strong quarterly performance and I believe it can sustain its growth in the future as it has made significant new investments that can increase its profitability.

About BBDC

BBDC is a global investment manager that sources differentiated opportunities across private and public fixed-income, real estate, and specialist equity markets. It is closed-end, non-diversified, and treated as a business development company. In 2018, the company began to shift its investment focus to invest in bonds, syndicated senior secured loans, and other fixed-income securities. After that period, it transformed its portfolio to primary senior secured private debt investments targeting middle-market businesses that operate in a diverse range of industries. It made new commitments of $118.9 million , of which $74.0 million was closed and funded. This investment primarily comprised $10.9 million of equity investments, $18.1 million of first-lien senior secured debt investments, and co-investment of $45.0 million in preferred equity with certain affiliates in portfolio firm that specializes in directly originated litigation financing loans to mass tort law firms. The company has over 1200 external clients spread across the Americas, Asia-Pacific, and EMEA, each contributing 42%, 31%, and 28% respectively to the AUM. In Platform investments, BDC invests in two originators of uncorrelated middle market first-lien loans. The company's share price has grown by 5.41% since the start of 2023.

Financials

During the last 3 years, BBDC's total investment income (revenue) has grown dramatically. In FY2021, the company recorded a revenue of $135.34 million which is a rise of 90.53% compared to $71.03 million in FY2020. The primary drivers of this growth were increased dividend payments from investments, associated portfolio velocity , and increased investment activity. In the same time frame, BBDC's NAV rose from $10.99 to $11.36 per share, a gain of 3.37%. The company continued this incredible revenue growth in FY2022. It reported revenue of $219.13 million which is a 61.9% increase compared to revenue of FY2021. The substantial performance of BBDC's investments and higher base rate were the main reasons behind this growth. The company's NAV at the end of FY2022 was $11.05 (a decrease of 2.73% YoY). The rising base rate has helped the company to continue this solid revenue growth in FY2023.

The private sector middle-market firms are highly developing and require financing to expand their businesses. The U.S. middle-market companies with earnings in the range of $50 million to $100 million have witnessed an 11.9% growth from 2022. In 2023, 81% of firms in the middle market reported a healthy revenue growth. I believe, that as these companies grow and expand their operations it can lead to a significant need for financing which can create high opportunities for the private lending participants as the market share of traditional financing sources has reduced dramatically due to the strict regulatory environment. I believe the company is strongly positioned to capitalize on this opportunity as it is highly focused on making new investments by utilizing its healthy cash positions and sourcing capabilities which can potentially help it to earn additional investment income and expand its profit margins. Recently in the third quarter, the BDCC experienced significant growth with 10 new investments of $64.5 million . It also invested $73.4 million in its existing portfolio companies. The Company made around $105.3 million in additional commitments after September 30, 2023, of which $96.7 million were completed and financed. I believe this increased focus on making new commitments can act as a catalyst to expand the company's profit margins as it can help it earn additional investment income by adding new industry participants to its portfolio.

The company reported its quarterly results on November 10th. It reported an investment income of $70.84 million, up 25.82% compared to $56.31 million in Q3FY23. The primary causes of this growth were significant expansion in the portfolio and high interest rates. The company has failed to achieve the market's revenue expectation by $2.21 million or 3.02%. Net Investment Income (Net income) surged by 19.33% YoY from $27.91 million to $33.30 million. The rise in NII was the result of the normalization of yields, continued strong credit performance, and lower incentive fees due to the incentive cap. The surged net investment income has led to an EPS of 0.31 which is $0.01 or 3.125% lower than the market's anticipated EPS. Net asset value per share stood at $11.25 decrease of 0.8% QoQ compared to $11.34 in Q2FY23. BDDC reported $49.75 million in liquidity.

The company has achieved significant growth in investment income despite macroeconomic pressures such as high inflation and the upcoming political cycle that led to high uncertainties in the industry. In addition, its strong sourcing capabilities have also facilitated it to expand its investment portfolio. It is observed that the company is making most of the opportunities obtained from the industrial tailwinds and I believe it can further sustain this growth in the future as it is highly focused on making new investments that can help it address the growing demand and increase its profit margins by earning additional investment income. The higher interest rates and expanded portfolio can help the company achieve a revenue of $70-75 million revenue in Q4FY23. Therefore, it is safer to say that BBDC's full-year revenue can fall in the range of $283.35 million to $288.35 million. I think the rising base rates might continue to increase the yields of the company's floating rate portfolio in FY2024 and the company has executed 10 new deals in Q3FY23. That is why, I think it's safer to say that the company can exceed the FY2023 revenue. Due to the upcoming political cycle, the Fed can reduce the interest rates in the market at the end of FY2024 however, they cannot decrease dramatically because of the high inflation. Therefore, I am keeping my revenue estimates conservative and predicting the company's revenue might be $295 million. BBDC's average net income margin is 47%. The company can maintain an average net income margin in FY2024 as well with the help of the high base rate. Therefore, I am forecasting that the company's net income margin for FY2024 to be 47% which gives the EPS estimate of $1.34.

Dividend Yield

The company has been paying dividends consistently and consecutively for the last 4 years. In 2023, the firm distributed cash dividends of $0.25 in each of the first two quarters and later increased this payout to $0.26 for the remaining quarters each, which makes the total annual dividend $1.02, representing a high yield of 11.74% compared to the present share price. Observing the company's increasing portfolio size and its healthy cash flows, I believe, we can expect a decent growth of payouts in the coming quarters. The company's management has stated that they are keeping their dividend policy conservative. So, even if the company decides to continue with a quarterly dividend payment of $0.26 which is a $1.04 annual dividend or 11.97% dividend yield compared to the current share price of $8.69. Even my estimated EPS ($1.34) supports the dividend payment of $1.04. BBDC's forward dividend yield of 11.97% is significantly higher than the sector median dividend yield of 3.61% and BBDC's 5-year average dividend yield of 8.40%. The company is an enticing option for risk-averse and retired investors who want capital appreciation in addition to dividend income.

What is the Main Risk Faced by BBDC?

The company mainly serves middle-market companies that are exposed to significant risks that can affect their ability to meet their debt obligations. These firms usually have narrower product lines, shorter operating histories, large customer concentrations, and smaller market shares, making them vulnerable to market conditions, competitors' actions, as well as general economic downturns. If any of these players fail to repay the loan or delay payments, it may reduce cash flows by reducing its profit margins.

Valuation

The company has reported strong quarterly performance as a result of strong industry demand and I believe it can sustain this growth in the future as it has recently made significant new commitments in two consecutive quarters which can help it to increase its investment income and expand its profit margins. After considering all the above factors, I am estimating an EPS of $1.34 for FY2024 which gives the forward P/E ratio of 6.49x. I believe the firm is undervalued based on a comparison between the forward P/E ratio of 6.49x and the sector median of 9.67x. In my opinion, the company may grow in the upcoming quarters as a result of the high base rate and expansion of its investment portfolio, which may enable it to trade beyond its present P/E ratio. The company's diversified & efficient portfolio can help the company to trade at the sector median P/E ratio in the coming period. Therefore, I estimate BBDC might trade at a P/E ratio of 9.67x in FY2024. The multiplication of an EPS estimate of $1.34 and a P/E ratio estimate of 9.67x gives a price target of $12.96, which is a 49.13% upside compared to the present share price of $8.69.

Conclusion

The company mainly serves the financial needs of middle-market firms in the U.S. and currently experiencing strong industry tailwinds due to the exponential growth of middle-market companies that has led to increased financing needs. It has reported a strong quarter and I believe it can sustain its performance in the future as it has significantly increased its investments in new as well as existing portfolio firms which can help it potentially increase its investment income and expand its profit margins. However, such firms are more vulnerable to changing market environments which can lead to defaults in case of failure of debt repayment and reduce the company's profitability. BBDC can pay a high dividend yield of 11.97% which makes it an attractive investment option. The stock is currently undervalued and we can expect a decent 49% growth from the current price levels as a result of its increasing new investments. Considering all the above factors, I assign a buy rating to BBDC.

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