ARCC - Main Street Capital Produced A Strong Q4 But It Could Be Overvalued

Summary

• MAIN delivered a strong Q4 and full year 2022 results on Thursday 2/23 after the bell.
• MAIN's management team is making all the right moves and delivering value in both the share price and the dividend for shareholders.
• I think MAIN is a hold as the premium on its NAV is too large for me, but I would get really interested in the $36-$37 range.

I am a shareholder of Main Street Capital ( MAIN ), but if I were going to allocate capital in the BDC space today, I wouldn't be adding to my position in MAIN. MAIN is one of the most popular BDCs on Seeking Alpha , and after the close on Thursday, 2/23/23, they delivered a monster Q4. MAIN's Q4 net investment income ((NII)) came in at $1.03, beating the consensus estimates by $0.15, and they also beat on total investment income as well. MAIN's net asset value ((NAV)) rose, and MAIN declared a special supplemental cash dividend on top of their 3 monthly scheduled dividends in Q2 2023. After reading through the earnings report, there is nothing not to like except the premium Mr. Market has placed on MAIN's NAV. On the other hand, MAIN trades at an attractive NII to market cap multiple, so it really depends on which number is more important to the individual investor when determining if MAIN is overvalued. I would love to add to my position, but I will be waiting for a pullback as the premium on its NAV is too large, and there seem to be better values within the space. Nevertheless, MAIN had a great year, and they are doing the right thing for shareholders by producing larger amounts of NII and rewarding shareholders with special dividends.

Main Street Capital delivered a strong 2022 fiscal year

From a numbers standpoint , I am impressed with MAIN's 2022 results. MAIN grew its total investment income by $87.81 million YOY to $376.86 million, which is an increase of 30.38%. MAIN's net investment income grew 34.30%, adding $62.66 million YoY. This drove the NII per share to $3.29 from $2.65, putting MAIN at a 12.6% ROE. MAIN's management team completed $372.8 million in total LMM portfolio investments, including investments totaling $137.2 million in five new LMM portfolio companies. After the aggregate repayments of debt principal and return of invested equity capital from several LMM portfolio investments, MAIN saw a net increase of $263.5 million in total LMM portfolio investments. MAIN also completed $712.9 million in total private loan portfolio investments, which after aggregate repayments and sales of debt investments and return of invested equity capital from several private loan investments, resulted in a net increase of $334.8 million in private loan portfolio investments.

MAIN had a strong year, and they rewarded shareholders, which is what investors should be looking for in a BDC. When the company does well, so should the shareholders, and MAIN was very generous when allocating capital to the dividend. In 2022, MAIN paid $2.60 in regular dividends, which was an increase of 4.8% YoY. The dividend didn't just grow through the regular monthly dividend, MAIN provided shareholders with a large supplemental dividend as well. Over the course of 2022, MAIN paid an additional $0.35 in supplemental dividends, which was an increase of $0.10 for 2021. In total, shareholders received $2.95 per share in dividends throughout 2022 from MAIN, which was a YoY increase of 14.4%.

Is MAIN overvalued today, or is now a good time to deploy capital?

Determining if MAIN is overvalued is a question that each investor needs to answer on their own. I will show the valuation metrics I look at when comparing BDCs and provide my opinion on this question. There are three metrics I use to evaluate against the peer group, which include the NII to market cap multiple, price to NAV discount, and the dividend yield. NII is a better metric than EPS to utilize for a BDC, so the NII to market cap is a more effective measure than a P/E ratio. This is why I utilize this metric to see how cheap BDCs are trading against their NII. I also like to see if there is a steep discount or a heavy premium with a BDCs price to NAV valuation in addition to looking at the yield and dividend coverage.

I will compare MAIN to the following companies:

• Gladstone Investment ( GLAD )
• Sixth Street Specialty Lending ( TSLX )
• Golub Capital BDC ( GBDC )
• Prospect Capital Corp. ( PSEC )
• Ares Capital ( ARCC )
• Owl Rock Capital Corp. ( ORCC )
• Barings BDC ( BBDC )
• MidCap Financial Investment Corporation ( MFIC )
• Goldman Sachs BDC ( GSBD )
• FS KKR Capital Corp. ( FSK )

Today, you're paying a great multiple on MAIN's NII. MAIN trades at a 12.66x NII to market cap multiple, which is the 2nd lowest in its peer group and significantly below the peer group average of 26.76x. If I was to take out BBDC and PSEC as they both trade above a 50x multiple, the peer group average would go down to 20.13x. From this aspect, MAIN looks very attractive.

The valuation metric that doesn't look attractive is MAIN's premium to NAV. MAIN has a share price of $40.19, and its NAV finished 2022 at $26.86. This puts MAIN's current value at a 49.63% premium based on its discount to NAV. The premium placed on MAIN's shares isn't even close to its peers as the 2nd largest, TSLX, trades at a 16.08% premium.

It's difficult because MAIN's discount to NAV and NII to market cap are opposites. On one end, MAIN looks cheap, and on the other, it looks expensive. Now I look at dividend yield, because this is an income investment for me. I don't add the supplemental dividends into this because they are not guaranteed. MAIN has a dividend yield of 6.57% which is much lower than its peer group. The 6.57% yield is interesting compared to CDs and T-bills, and is larger than most companies in the S&P, but compared to its peers, it's lacking.

Conclusion

I am torn because since I started following MAIN it has always traded at a larger premium than its peers based on its share price to NAV. MAIN's leadership has done a fantastic job delivering value for its shareholders, and they have no control over the premium Mr. Market places on its shares compared to the NAV. MAIN does trade at an attractive NII to market cap ratio, and even though the dividend yield is low compared to its peers, it's still a strong dividend yield, especially when the supplemental dividend is factored in. I wouldn't be surprised if MAIN catches a bid and trades up 5-10% or if shares retrace into the mid or high $30 range. While I love most of the metrics, I think MAIN is a hold, and I would get really interested in adding to my position around $36 or $37.

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