Ares Capital Stock: Dividend Growth Expected to Continue (NASDAQ:ARCC)
Ares Capital (ARCC) is a leading blue chip BDC. It has a long track record of maintaining or increasing its dividend, prudent allocation of shareholder capital which has allowed it to consistently compound the net asset value per share and ultimately drive performance above the market. In fact, management announced on its last earnings call that:
During the quarter ended September 30, 2021, which is the last full reporting quarter for BDCs, Ares Capital recorded the highest regular base dividend growth rate per share and the highest net asset value growth rate per share. highest share over the past 5 and 10 year periods. , among all externally managed BDCs with a market cap of more than $700 million.
If there’s been a negative on ARCC, it’s that the company has lagged some of its peers in terms of quarterly dividend growth over the past few years. However, the company dismissed that criticism when it resumed dividend growth last year in the second half and sustained it into early 2022 with a sequential rise of 9% YoY/3.9% in the first. trimester. However, we don’t think ARCC is done with dividend growth yet. In this article, we give 3 reasons why we think dividend growth should continue.
#1. Solid dividend coverage
Dividend coverage is perhaps the most difficult and important reason why a BDC is about to increase its dividend. The reason we say this is the most difficult reason is that BDCs are required to distribute 90% of their taxable income to maintain their BDC status, so it’s hard to get strong coverage from dividends for a very long time.
However, the ARCC succeeded in achieving this goal. Last quarter, ARCC paid $0.4044 per share in dividends, but managed to cover that very easily (1.43x) with $0.58 per share in adjusted earnings.
This year, analysts expect the company to generate $1.89 in normalized earnings per share, compared to the current annualized dividend rate of just $1.68. This results in a payout ratio of 88.9% which, while not low, nevertheless leaves substantial flexibility for other dividends. Management addressed this expected shortfall by announcing additional dividends totaling $0.12 per share for 2022, to be distributed in four consecutive quarterly installments of $0.03 per share per quarter.
More importantly, ARCC’s dividend coverage is also bolstered by its large ripple income. On the earnings call, management said:
Given our strong earnings for the year, we once again exceeded the dividends we paid, resulting in an increase in our undistributed taxable income, sometimes referred to as our ripple effect. We currently estimate that our 2021 overhead income, after taking into account shares issued in our January capital raise, was $1.30 per share, an increase of $0.24 per share over the level of 2020.
Expanding our impact was a significant consideration in our decision to pay additional quarterly dividends totaling $0.12 per share in 2022. The first additional dividend of $0.03 per share is also payable March 31, 2022 to shareholders. registered on March 15, 2022. . We will continue to monitor our retained earnings and balance sheet levels against prudent capital management considerations. Overall, we believe that having strong and meaningful retained earnings supports our goal of maintaining a stable dividend in varying market conditions and sets us apart from many other BDCs without our level of earnings.
Between the strong quarterly dividend coverage and the continued level of significant spillover income, it is highly likely that ARCC will continue to increase its quarterly dividend in the years to come.
#2. Solid Investment Grade balance sheet
ARCC has a healthy investment-grade balance sheet, earning a BBB- credit rating from S&P and an equivalent Baa3 from Moody’s, while Fitch assigns it a BBB rating. As a result, the company is able to access many inexpensive debts on very favorable terms (weighted average interest rate of 2.013% and weighted average interest rate of unsecured debt of 3.429%).
With most of its debt maturing in 2025 or later, ARCC’s liquidity and financial position appear very strong. Combined with its strong portfolio of investments and its common stock price which currently trades at a healthy premium to net asset value, ARCC should be able to continue to generate highly accretive growth for shareholders, further increasing the earnings per share which will translate directly into a growth in the dividend per share.
#3. Healthy and well-diversified portfolio
Last but not least, we are confident in ARCC’s ability to continue to increase its dividend over time, as it has a very well-diversified and well-performing portfolio.
Only 0.5% of its portfolio at fair value (0.8% at amortized cost) is in a non-recognition situation. This is a substantial decline from 1.0% and 1.7% respectively in the prior quarter and 2.0% and 3.3% year over year.
Meanwhile, the investment portfolio is diversified among 387 different borrowers with an average holding size of just 0.3% at fair value. Outside of investments in highly diversified funds, no investment represents more than 1.5% of ARCC’s portfolio at fair value, and its top 10 investments represented only 10.9% of the portfolio at fair value at end of the fourth quarter. Additionally, the loan to value in debt portfolio is quite conservative at around 45%.
Given the health and diversification of the portfolio, we believe ARCC is well positioned to weather market turmoil without incurring huge permanent losses to net asset value per share.
Key takeaway for investors
Dividend growth is considered by many to be the holy grail of investing. In fact, investing in stocks that pay dividends – especially growing dividends – has proven over time to be a superior strategy to investing in stocks that don’t pay dividends.
At High Yield Investor, we aim for an attractive combination of quality, dividend growth and high current yield, to maximize compounding. One of the best stocks to fit this profile is Ares Capital Corp.
This is what allows us to generate oversized weighted average returns (5% to 6%) relative to the broader market while delivering substantial outperformance:
|HYI Core Wallet||54.8%|
|S&P 500 (SPY)||21.7%|
We believe that holding ARCC in our retirement portfolio allows us to sleep well at night while reaping the rewards of a distant current yield (8%+) which is also very likely to continue to grow for the next three years. reasons stated in this article.