2023-08-31 15:17:31 ET
Summary
- Main Street Capital is a well-established BDC with a track record of delivering rising dividends and book value.
- MAIN has industry-leading cost structure and solid returns, making it an attractive investment option.
- Alexandria Real Estate is a leading landlord in the growing Life Sciences category, with properties in desirable locations and high barriers to entry.
It pays to stick with those stock that have durable business models and industry leading attributes. That's because once a company establishes a competitive advantage, it only gets easier to win new business at rates that are accretive to shareholders. This goes back to the economist and stock analyst Jeremy Siegel who advocates buying "the tried and true vs the bold and new."
The following 2 picks are prime examples of that. Both have industry leading qualities about them that puts them a step above the competition. In this article, I explore what makes each of them attractive for investors who prize a well-above average yield and sleep well at night attributes, so let's dive in!
Pick #1: MAIN
Main Street Capital ( MAIN ), which I last covered here in May with a Buy rating, is one of just a handful of internally-managed BDCs, and it provides direct lending to a diverse array of customers across industries in the U.S., as shown below.
MAIN carries a respectable track record of shareholder returns through conservative lending practices and management acumen. It's also benefitting from higher interest rates due to its debt investments being floating rate, with a weighted average yield of 12.9% during the last reported quarter.
Investors don't buy MAIN to get rich overnight, unless of course if the market panics and sends the stock down to the teens, as we saw in 2020. Rather, they buy the stock for its durable track record of delivering a rising dividend stream and raising the book value.
This is perhaps best exemplified by the following chart, which shows how MAIN has weathered through two major economic events over the past 15 years, including the Great Recession of 2008 and the Pandemic of 2020. In both cases, MAIN not only survived but thrived in the period thereafter with a rising NAV/share and solid growth in distributable NII per share. MAIN has also never cut its dividend since inception.
A key reason for why MAIN has been able to produce great results is its industry-leading cost structure, enabling more capital to flow to the bottom line for shareholders. This is reflected by MAIN's operating expense ratio of 1.4% , which actually sits lower than the 1.5% base management fee of many externally-managed BDCs like Ares Capital ( ARCC ). This is not to mentioned additional incentive performance fees that can be layered on top of the base fee by externally-managed BDCs. Having a low-cost structure also makes MAIN more prepared to handle financial adversity in the same manner that an individual with low monthly expenses can handle the lean times.
Meanwhile, MAIN continues to produce solid returns, generating an ROE of 19% during the second quarter. Another positive is that NAV/share has grown by 3.1% since the start of the year to $27.69, and the DNII to dividend coverage ratio is at a very healthy 1.59x, thereby leaving plenty of retained capital for reinvestment and/or special dividends.
What's interesting about MAIN is the fact that it acts as an external advisor for privately managed funds. This creates another source of recurring revenues for the company outside of its core direct lending business, and management is optimistic around growing this segment. Also, despite economic uncertainty, management sees the pipeline as being on par with historical norms, no better and no worse.
Concerns around MAIN include economic adversity, which could put pressure on borrowers. This could result in a reduction in dividend payments from MAIN's equity investments. Also, while interest rates remain high, an interest rate cut in the future could result in yield compression.
Another concern that investors may have for MAIN stems from its valuation, which at the current price of $40.31 equates to a price-to-NAV of 1.46. While some investors understandably don't like paying such a high premium to book value, I believe well-run internally managed BDCs should be valued more on their earnings power than book value.
Plus, that's also how efficiently run BDCs with low operating costs like MAIN are able to pay a 6.8% dividend yield despite trading at a substantial premium to NAV. From this perspective, MAIN doesn't appear to be expensive at a forward PE of just 9.8. with a low regulatory debt to equity ratio of 0.75, implying plenty of flexibility to add leverage and grow its income. As such, MAIN gives investors the opportunity for an attractive, high quality yield at the current price.
Pick #2: ARE
Alexandria Real Estate ( ARE ), which I last covered here back in March with a Strong Buy rating, is officially an office REIT and has seen its price drop substantially over the past year, as shown below, as investors have apparently thrown this stock out with the bathwater.
I view this drop as being undeserved, considering that ARE is the leading landlord to tenants in the growing Life Sciences category. This includes 825 tenants across the pharmaceutical space in innovation clusters like South San Francisco, New York City, San Diego, Seattle, Maryland, and Research Triangle in North Carolina.
ARE's properties in these cities benefit from the "cluster effect", as tenants find these locations desirable due to their proximity to well-educated talent in research institutions and other companies nearby. Plus, the high cost and limited space for development in these innovation clusters result in high barriers to entry for new players.
This is reflected by the fact that 82% of ARE's leasing activity in the first half of the year was generated from its existing tenant base. Moreover, 90% of ARE's rent stems from investment-grade rated or large cap publicly-traded companies. These durable attributes contributed to ARE's respectable 7.4% annual CAGR in FFO per share over the past 10 years.
Concerns around ARE stems from general economic uncertainty and potential for additional drug price reform. This includes the potential for an expanded number of drugs to be added to the list in which Medicare can negotiate with pharmaceutical companies on prices. This could harm ARE's tenant profitability and result in lower available funds for new drug research.
Nonetheless, ARE's growth thesis appears to be intact for the foreseeable future, as it's seeing heightened demand from tenants, and management believes that they see a light at the end of the tunnel amidst the current macroeconomic uncertainty. In addition, occupancy remains solid at 94% and lease spreads on new and renewal leases were at 16% and 8% on an GAAP (straight-line rent) and cash basis, respectively. This is far higher than the flat lease spreads (on a cash basis) that some traditional office REITs are seeing in the current environment.
Meanwhile, ARE maintains a strong BBB+ rated balance sheet to fund its development pipeline. This is supported by no debt maturing prior to 2025, $6.3 billion in total liquidity, a low net debt to EBITDA ratio of 5.2x (management targets below 5.1x by the end of this year, and strong fixed charge coverage ratio of 4.7x.
Importantly, the dividend is well-protected by a 55% payout ratio, based on management's guidance for FFO/share of $8.96 for 2023 at the midpoint. While, ARE's dividend yield of 4.2% isn't what some investors would consider high yield. It sits far higher than the 1.45% yield of the S&P 500 ( SPY ) and has potential to accelerate dividend growth, given that management expects for cash re-leasing spreads to nearly double from the present level to 14.5% in the near term.
As such, I view the current $117.82 price with forward P/FFO of 13.2 to be far too cheap for assets of ARE's quality. As shown below, this also sits well below ARE's normal P/FFO of 17.7. Therefore, investors seeking high quality yield ought to consider ARE at the present price.
Investor Takeaway
Thanks for reading! MAIN and ARE are 2 high quality yields that are hard to go wrong with over the long run. Both have unique attributes that separate them from the pack, and this translates into durable competitive advantages. Meanwhile, investors get to collect well above average yields from these 2 players for potentially strong "sleep better" at night type of total returns over the long run.
For further details see:
Boost Your Income With Dividends From ARE And MAIN