MAIN - Better High-Yield Blue-Chip Buy: Ares Capital Vs. Main Street?

2023-11-13 17:54:49 ET

Summary

• Ares Capital Corp and Main Street Capital are leading Business Development Companies.
• They also have some of the most impressive track records in the sector and have crushed the market over the long term.
• We compare them side-by-side and offer our take on which is the better buy right now.

Ares Capital Corp ( ARCC ) and Main Street Capital ( MAIN ) are both among the bluest of the blue-chip Business Development Companies, or BDCs ((BIZD)). Both have generated fantastic long-term outperformance of the SPDR® S&P 500 ETF Trust ( SPY ):

In this article, we share our opinion on which one is the better buy after reporting their latest quarterly results.

ARCC Stock Vs. MAIN Stock: Quarterly Results Recap

ARCC reported solid Q3 results . NAV per share increased by $0.41 (2.2%) sequentially, due to a combination of unrealized gains in the portfolio as well as some retained earnings after paying out dividends. Core EPS improved by 1.7% sequentially and by 18% year-over-year. The weighted average yield on debt and other income-producing investments improved by 20 basis points sequentially, to 12.6% on a fair value basis. Non-accruals improved from 1.1% to 0.6% on a fair value basis and from 2.1% to 1.2% on an amortized cost basis sequentially, reflecting continued improvements in the portfolio's fundamentals.

MAIN's quarterly results were also quite strong. NAV per share increased by $0.64 (2.3%) sequentially, due to a combination of unrealized gains in the portfolio as well as some retained earnings after paying out dividends. Core EPS improved by $0.04 (3.8%) sequentially and by $0.16 (15.4%) year-over-year. Non-accruals stood at 1% of the portfolio on a fair value basis and 3.1% on a cost basis. The weighted average effective yield of the portfolio stood at 12.8%.

ARCC Stock Vs. MAIN Stock: Balance Sheet

Both ARCC and MAIN have investment-grade credit ratings and solid balance sheets. ARCC's leverage ratio is 50.25% whereas MAIN's is 43.31%. MAIN's total liquidity is over $420 million (compared to an enterprise value of $5.2 billion) whereas ARCC's total liquidity is $5.3 billion (compared to an enterprise value of $22.2 billion). Both companies also have well-laddered debt maturity profiles

MAIN maintains a conservative capital structure, highlighted by its mix of secured, floating-rate revolving debt, and unsecured, fixed-rate long-term debt. This includes a $995.0 million corporate facility with a floating interest rate of SOFR+1.875%, maturing in August 2027, with $323.0 million drawn. Additionally, there is a $255.0 million SPV Facility at SOFR+2.50%, maturing in November 2027 with $170.0 million drawn. MAIN also has notes payable at various fixed interest rates and maturities, including a significant $500 million note at 3.00% fixed interest, redeemable at MAIN's option before its maturity in 2026, and a $450 million note at 5.20% fixed, maturing in 2024.

ARCC presents a more complex debt structure with multiple layers of secured and unsecured debt. As of September 30, 2023, ARCC's aggregate committed/amount outstanding includes secured revolving facilities totaling $8.123 billion, with various maturity dates stretching to April 2028. They also have a sizeable amount of unsecured notes payable, with the largest single maturity of $1.250 billion in July 2025 at an interest rate of 3.250%. The total debt at ARCC amounts to $15.783 billion, with the weighted average interest rate reflecting a combination of floating and fixed rates. The floating-rate debt is substantial at $7.805 billion, showing a preference for flexible rate instruments to help hedge its floating-rate heavy investment portfolio.

ARCC Stock Vs. MAIN Stock: Investment Portfolio

When it comes to investment portfolios, MAIN has a lower expense ratio given that it is internally managed whereas ARCC pays a significant external management fee to Ares Management Corporation ( ARES ) in exchange for benefiting from its vaunted direct lending and private credit platform.

ARCC's asset class allocation is heavily weighted toward first-lien senior secured loans at constitute 43% of its portfolio, followed by second-lien senior secured loans at 17% and senior subordinated loans at 11%. It is also broadly diversified across numerous industries, with the largest allocation in software and services at 23%, followed by consumer durables and apparel, and financial services, each comprising 11% of the portfolio.

In comparison, MAIN's asset class allocation is strategically distributed across Lower Middle Market, Private Loan, and Middle Market investments. The portfolio predominantly invests in secured debt while also allowing room for equity growth investments. The LMM segment forms a large part of the portfolio's fair value and is characterized by secured debt investments in high-quality, well-established assets that offer attractive risk-adjusted returns. The Private Loan portfolio is also quite large and is composed primarily of secured debt. Finally, the Middle Market investments, are geared towards providing liquidity that supports future investment activities. Overall, MAIN is 68.8% invested in senior secured loans, with the remainder being divided fairly evenly between common and preferred equity investments.

ARCC Stock Vs. MAIN Stock: Dividend Outlook

Both companies have lengthy track records of sustaining and/or growing their dividends. Moving forward, this appears likely to remain the case as both companies are covering their current dividends quite well.

MAIN's management had this to say about its dividend on their latest earnings call :

Our Board declared a supplemental dividend of $0.275 per share payable in December, representing our ninth consecutive quarterly supplemental dividend. Our Board also declared another increase to our regular monthly dividends for the first quarter of 2024 to $0.24 per share...representing a 6.7% increase from the first quarter of 2023 and representing our fifth increase to our monthly dividends in the last six quarters. The supplemental dividend for December is a result of our strong performance in the third quarter, which resulted in DNII per share, which exceeded our regular monthly dividends paid during the quarter by $0.35, or 51%.

The December supplemental dividend will result in total supplemental dividends paid during the trailing 12-month period of $0.95 per share, representing an additional 35% paid to our shareholders in excess of our regular monthly dividends and resulting in a current yield we are providing to our shareholders of approximately 10%. After the multiple recent increases to our monthly dividend and the significant supplemental dividend, our DNII per share for the third quarter still exceeded our total dividends paid by $0.075 per share or 8%... Based upon our expectations for continued favorable performance in the fourth quarter, we currently anticipate proposing an additional supplemental dividend payable in the first quarter of 2024.

Clearly, MAIN's base dividend is very safe and it appears highly likely that it will continue to deliver attractive supplemental dividends to shareholders for the foreseeable future. Moreover, analysts currently forecast its dividend to grow at a 9.2% CAGR through 2025.

ARCC's management, meanwhile, had much less to say about its dividend on its latest earnings call , merely highlighting the fact that ARCC is:

one of the few BDCs that's been able to deliver a consistent or growing regular dividend while building NAV over long periods of time.

Analysts are not nearly as bullish on ARCC's dividend growth prospects moving forward, either, with the consensus estimating that it will grow its dividend at a meager 1% CAGR through 2025.

ARCC Stock Vs. MAIN Stock: Valuation

While MAIN may have significantly stronger dividend growth potential, ARCC's starting yield is much higher than MAIN's and its valuation is much less expensive as well. MAIN's NTM dividend yield is 7.1% whereas ARCC's is 9.9%. MAIN's NTM price-to-earnings ratio is 10.23x, whereas ARCC's is 8.34x. MAIN's P/NAV is a whopping 1.42x, whereas ARCC's is 1.03x. As a result, investors in MAIN are buying with the assumption of considerable future growth, whereas ARCC's investors are paying almost fair market value for current performance alone.

ARCC Stock Vs. MAIN Stock: Which Is The Better Buy?

Both BDCs have exceptional track records of growing NAV per share over the long term and have proven to be very dependable dividend payers, even during periods when industry peers are having to slash dividends and/or seeing their NAV per share plummet.

Both also have strong balance sheets today along with well-diversified portfolios that balance more defensive senior-secured debt investments with more aggressive equity investments.

That being said, the main difference between them is that MAIN has a lower management expense and stronger growth prospects, whereas ARCC has a much higher current yield and a cheaper valuation relative to NAV. As a result, investors more interested in maximizing long-term dividend growth should favor MAIN whereas value investors who want to guard against downside potential and maximize current yield should favor ARCC. We rate both Main Street Capital and Ares Capital as a Hold at the moment, as neither appears to be trading for a particular bargain valuation and the risk of recession (which often brings a jump in non-accruals and a decline in profits for BDCs) is rising.

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