BIZD - BIZD: Strong 10.7% Dividend Yield Improved Growth Prospects

2023-12-09 22:23:03 ET

Summary

• BIZD has outperformed most other asset classes and indexes in 2023.
• BIZD's dividends have seen double-digit growth due to past Federal Reserve hikes and widening credit spreads, but growth is stalling.
• Default rates are rising, which could decrease earnings and increase investor risk for BIZD.
• An overview of the fund and some of its more recent development follows.

The VanEck Vectors BDC Income ETF (BIZD) has had an outstanding 2023, with the fund seeing double-digit dividend growth, and significantly outperforming the market. Owing to the fund's strong performance and investor interest, thought to have a quick look at recent developments concerning the fund, to see if outperformance is likely to continue.

BIZD's dividends have seen double-digit growth YTD, due to past Federal Reserve hikes and widening credit spreads. Growth is stalling, however.

BIZD's underlying holdings are seeing increased opportunities for growth, as economic conditions stabilize, and due to lower competition from regional banks.

Default rates are rising, which should somewhat decrease underlying earnings, and increase investor risk.

BIZD trades with a higher share price but a cheaper valuation, as underlying earnings growth has outpaced increases in share prices.

In my opinion, fundamentals remain strong, and have slightly improved these past few months. As such, BIZD remains a strong investment opportunity and a buy.

BIZD - Recent Developments

Quick Fund Overview

Some quick context first.

BIZD invests in business development companies or BDCs. BDCs are financial institutions that provide funds, generally loans, to small- and medium-sized enterprises. BDCs are generally diversified, although less so than the average mega-cap bank, and smaller too. BDC earnings are roughly equivalent to the net income produced by their loan portfolios.

Strong Dividend Growth

BIZD's dividends have seen strong growth recently, increasing by 12.4% these past twelve months. The fund currently yields 10.7%.

Dividends have grown for two key reasons: Fed hikes and wider credit spreads.

Federal Reserve hikes mean higher interest across fixed-income asset classes and securities, including BDC loans. As an example, the underlying portfolio of Ares Capital ( ARCC ) has seen its yield increase by around 1.7% these past twelve months. ARCC is BIZD's largest holding, and representative of the industry and the fund.

BDC loans are generally made to riskier companies, so interest rates are strongly dependent on credit spreads. Spreads have widened for the past two years as economic conditions have somewhat deteriorated since late 2021, and as higher rates decrease the demand for high-yield assets (T-bills yield more than enough for many investors). Spreads for the wider high-yield market have widened by about 0.8% since early 2022. Spreads peaked in mid-2022, and have trended down ever since.

Spreads for most BDC loans have widened too, as per my research. Ares Capital management claims the same, stating that credit spreads on new loans are well above historical averages in their latest earnings call .

Higher interest rates and wider credit spreads have led to double-digit dividend growth for BIZD, a significant benefit for the fund and its investors.

On a more negative note, growth seems to have stalled these past few quarters. BIZD's dividends are very volatile, however, so this might not mean much.

Higher Default Rates

As mentioned previously, credit spreads have widened due to deteriorating economic conditions. Specifically, default rates are rising, reaching 3.2% this past October . Default rates are likely to rise in the coming months, with S&P forecasting a 4.4% - 4.5% rate for mid-2024 . Ares Capital expects modestly higher default rates next year as well. Both figures are higher than in recent years, but not significantly higher than the long-term average of 3.6%.

For BIZD's underlying holdings, higher default rates mean reduced assets and income. Depending on their magnitude, dividends might get cut, and companies might suffer significant, permanent capital losses. Current and forecasted default rates do not seem high enough for this to occur, but the situation is in flux, and markets do not always act rationally.

Higher default rates are a significant, straightforward negative for BIZD and its shareholders, and cancel out a portion of their higher yields. For more bearish or risk-averse investors, higher default rates might make an investment in BIZD exceedingly risky or unwise.

Share Prices and Valuation

BIZD's share price is up 9.3% YTD. Combined with double-digit dividends, the result has been strong, market-beating total returns. Prices have increased due to improved investor sentiment and as interest rates have started to stabilize.

On the other hand, valuations have, if anything, decreased instead. PE ratios are down, from 14.4x earlier in the year to 9.6x as of today. PB ratios have remained the same, at 0.9x.

In my opinion, PB ratios are the more informative metric for BDCs right now, as earnings are fluctuating a lot due to aggressive changes in interest rates and spreads. As such, I would argue that BIZD's valuation has not materially changed YTD. Considering the strong capital gains and total returns realized by the fund, this is welcome news to investors.

Increased Growth Opportunities

BDCs are in the business of making corporate loans, so opportunities for growth are dependent on credit markets and corporations needing financing. Loan growth stalled earlier in the year, as evidenced by sluggish bank credit growth from March to July:

Ares Capital said the same in their 1Q2023 earnings call , stating that new deal activity was low at the time.

Growth resumed mid-July, however, as can be seen in the graph above. Ares Capital also stated that new deal flow had increased by around 33% this past quarter .

In all honesty, I am not entirely sure why growth resumed, or why BDC growth has been so strong. Interest rates remain high and although the economic conditions are good, they are not that good. Ares Capital management credits regional banking woes for a big chunk of the growth, as issues in that sector mean less competition for BDCs.

In any case, it seems clear that BDCs are seeing increased growth opportunities, which should lead to higher earnings and dividends moving forward. Growth is highly uncertain, however.

Conclusion

BIZD has had an outstanding 2023, with the fund significantly outperforming the market. Fundamentals have mostly improved too, with the exception of increased default rates.

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