BBDC - Barings BDC Isn't Well Known But Maybe This 11.76% Yielding BDC Should Be

2023-10-24 09:00:00 ET

Summary

• Barings BDC is a smaller BDC with potential as the Fed's tightening cycle ends and investors seek higher-yielding alternatives.
• BBDC focuses on debt investments in middle-market companies and has a strong track record of growing its investment income and dividend.
• BBDC is undervalued compared to its peers, trading at a discount to NAV and offering a higher yield of 10.86%.

After doing some pre-earnings research on Barings BDC (BBDC)) I was surprised that only 5,430 Seeking Alpha members followed this Business Development Company ((BDC)). It seems like the BDC space is dominated by Ares Capital (ARCC), FS KKR Capital (FSK), and Blue Owl Capital (OBDC), but some of the smaller BDCs, such as BBDC, may be interesting investments as we end the Feds tightening cycle. Barings is up 7.54% YTD and has grown its quarterly dividend by 62.5% over the past three years. While BBDC has a smaller market cap and net asset value (NAV) than its peers, BBDC is managed by Barings LLC, a $347 billion global investment manager with a long history of success. Over the next year, I believe that the Fed will pivot, and rates will start to decline, making risk-free assets less appealing, and investors will start to deploy capital sitting on the sideline back into the markets. Lesser-known BDCs such as BBDC could become very attractive as income investors look for higher-yielding alternatives to CDs and treasuries with a history of growing dividends. BBDC trading under $10 looks compelling, and I plan on adding more to my position.

What Barings BDC Does and Why it Looks Interesting

BBDC is a BDC that makes debt investments into middle-market companies. BBDC is focused on investing in senior secured private debt investments in well-established middle-market businesses operating across various industries. BBDC looks to generate current income by investing directly in privately held middle-market companies to help these companies fund acquisitions, growth, or refinancing. Barings, which is a leading global asset management firm, is BBDC's investment advisor. Barings primary investment capabilities include fixed income, private credit, real estate, equity, and alternative investments. BBDC focuses on middle-market companies providing customized financing solutions through consistent underwriting policies and active portfolio management. Like other BDCs, BBDC focuses on debt and equity investments. BBDC's debt portfolio predominantly consists of senior secured private debt investments while they also acquire equity interests in portfolio companies that are structured as non-control investments that provide minority rights.

At the end of Q2, BBDC's portfolio was $2.51 billion in size, with 328 portfolio companies. BBDC has 74% of its investments allocated toward senior secured debt at a 635 bps average weighted spread. 90% of its debt investments are based on a floating rate methodology, and the portfolio has an 11.3% yield at fair value. BBDC looks interesting to me because they have grown its investments at fair value by 4.89%, and its portfolio's total investment income was generated by 35.46% from the end of Q2 2022 to the end of Q2 2023. We're in a higher for longer rate environment, so BBDC's floating rate issued debt should be an additional asset allowing them to continue delivering additional investment income for the foreseeable future. While one could argue that fixed rate debt allows a company to forecast results into the future more accurately, there is a significant spread on floating rate debt above where the Fed Funds Rate is, and in the current rate environment, floating rate debt is able to deliver additional income for BBDC.

BBDC has grown its investment portfolio to a point where they have delivered significant dividend growth to its investors. Excluding the Q3 2018 dividend, BBDC has grown the quarterly dividend by 160% from Q4 2018 through Q3 2023. BBDC hasn't waited to reward shareholders and moved away from an annualized increase to increase the dividend when the company could distribute more income. Over the past 20 quarters, BBDC has increased its dividend 14 times, which has led to $3.82 being paid since the Q3 2018 dividend was paid. As BBDC continues to make new investments and expand its portfolio, the underlying assets should put management in a position where it can continue providing dividend increases to its shareholders. I think that BBDC is doing a lot to provide value to shareholders, and when I look at BBDC compared to other BDCs, I am surprised it's not more closely followed.

How Barings BDC stacks up to its BDC peers

I use a large peer group when comparing the BDC, which consists of:

• Prospect Capital Corporation ( PSEC ).
• Barings BDC ( BBDC ).
• Main Street Capital ( MAIN ).
• Blue Owl Capital Corporation ( OBDC ).
• MidCap Financial Investment Corporation ( MFIC ).
• Goldman Sachs BDC ( GSBD ).
• Oaktree Specialty Lending Corporation ( OCSL ).
• Golub Capital BDC ( GBDC ).
• Ares Capital ( ARCC ).
• Gladstone Investment ( GAIN ).
• Sixth Street Specialty Lending ( TSLX ).
• FS KKR Capital Corp ( FSK )

Of these 12 BDCs, BBDC is the 3rd smallest, with a market cap of $941.6 million. Just because BBDC is smaller than many well-known BDCs doesn't mean that it should just be looked over. BBDC has a compelling story when it comes to how it's valued compared to its peers.

The first thing I look at is the market cap to NII multiple. I want to pay the lowest multiple I can for a quality BDC. Today, BBDC trades at a 7.46x NII multiple compared to its market cap, while the peer group average is 8.15x. To me, this means I am paying an attractive price for shares of BBDC.

The next aspect I look at is the discount to NAV a BDC trades at. I don't mind paying a premium for quality assets, but I love paying a discount. BBDC trades at the 2nd steepest discount to NAV at -22.05% while the peer group trades at a -4.73% discount. BBDC has a NAV of $11.34 per share, and at today's prices, shares can be acquired at $8.84. Paying below the NAV at such a steep level could be an opportunity.

BDCs are income investments for me, so I want to see how much yield the investment will generate. BBDC currently yields 10.86%, which is slightly above the peer group average of 10.53%. The yield is more than double the rate of many risk-free investments and is large enough that I am interested in BBDC.

Why I think high-yield equities that have strong underlying fundamentals will do well in 2024 and 2025

We live in an environment where the risk-free rate of return is overshadowing many income investments. The 12-month treasury has a 5.42% yield, while the 10-year has a 4.91% yield. Investors looking for income have attractive alternatives to equities that are not only lucrative but also risk-free. I feel that this has hurt the equity market for income-producing assets because there has been so much uncertainty in 2023 that rates above 4.5% have become extremely attractive. I know several people who have created treasury and CD ladders with capital maturing every 3 months and the idea that if the investment environment gets better, they will just move that capital back into the market rather than rolling it back into a risk-free alternative. It's estimated that over $5 trillion is piled up in money market accounts and unless rates start to decline, I feel that the 5% risk-free appeal will be tough to pass up or even lock in for an extended period.

I think higher for longer is positive for high-yield investments such as BBDC. Please don't take what I am about to say out of context because I am looking at this from an income perspective, not from a capital appreciation stance. Investors who are focused on income are now used to the risk-free rate of return exceeding 4% and, in some cases, exceeding 5%. The projections indicate that it will take significant time for rates to decline and that the median rate in 2025 will be 3.9%. Equities that are generating a 2-3% yield probably won't be as appealing when rates start to decline because investors were used to generating more from CDs and bonds. When rates were under 1%, a 3% yield from equities was appealing, but going forward, I think lower yields will have less appeal. I think that investors will be used to generating mid-single-digit yields and will look to replicate these in the equity market when rates decline. My feeling is that investors will want to generate additional yield for taking on equity risk and that BDCs, REITs, and MLPs will come back into favor because there is additional spread to pad the downside. I think investors will look for underappreciated assets, and BBDC checks off all the boxes.

Conclusion

BBDC may have fewer followers and be a smaller BDC than some of its peers, but its managed by Barings, which is a $347 billion global investment manager and has established a strong track record across many aspects. BBDC has established a solid track record of growing its investment income, its portfolio, and its dividend over the past several years. Today, shares of BBDC are trading at a -22.05% discount to its NAV while yielding 10.46%. I think BBDC will continue to make strong strategic investments while rates are elevated, providing additional income for years to come. When the Fed pivots, I think a focus will be on higher-yielding equities, and BBDC could see additional allocated capital flow its way as investors look for underappreciated investments. I like paying a discount when I allocate capital toward investments, and I am more than willing to pay a 7.46x multiple on BBDCs NII. I may be investing in a smaller BDC, but the metrics are compelling, and I think BBDC is positioned well for the future.

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