Ares Capital Stock: load the truck with 9.3% ARCC yield

Galeanu Mihai/iStock via Getty Images

Ares Capital Corporation (NASDAQ: ARCC) and other high-quality business development companies are currently trading at or near their best valuations in over a year.

Ares Capital has remained one of the top BDCs to hold since its inception due to its hedging a dividend-focused portfolio, secure first lien and consistent ROE results.

Ares Capital shares are also trading at a discount to their book value, making BDC a particularly attractive dividend investment.

Switch to high quality BDCs

With a recession set to hit the U.S. economy in 2022 or 2023 and growth stocks battered one after another, high-quality business development companies like Ares Capital have the potential to generate strong returns for investors. shareholders.

Business development companies lend money to businesses that are underserved by the traditional financial sector, due to heightened risk aversion following the financial crisis of the 2000s. Ares Capital has found a profitable niche lending money to middle-market companies, and BDC’s investment strategy is based on a strict “don’t lose money” lending policy.

Ares Capital invests primarily in senior secured loans with a high probability of repayment by BDC borrowers. In the first quarter, 71% of Ares Capital’s portfolio was invested in secured loans, the majority of which were first and second lien, as well as loans made to businesses through the senior direct lending program of the company. These privileges are of exceptional quality and are extremely unlikely to be lacking.

Ares Capital - Highly diversified and mainly senior secure portfolio

Portfolio Summary (Ares Capital Corp)

Solid and consistent returns for shareholders

Investors are starting to worry and the valuations of commercial development companies reflect this. Even ARCC, which has good credit quality, a diversified portfolio and a good overall investment record, started trading at a discount to book value.

Ares Capital is one of the best BDCs in the market due to its strong ROE results over the past decade. Ares Capital’s book value has increased by 27% since inception, while the dividend has remained well covered.

Ares Capital delivered 45% dividend growth on top of 27% book value growth, making ARCC one of the top business development companies to own for dividend generation.

Ares Capital Solid investment performance

Strong investment performance (Ares Capital Corp)

Ares Capital’s success has been supported by consistently strong investment results (strict due diligence). Since 2005, BDC has posted an average return on core equity of 10%.

Ares Capital achieved even stronger financial results during the Covid-19 pandemic, with returns on equity of 10.6% (2020) and 11.2% (2021). Ares Capital’s portfolio performance differs from that of other business development companies in its length and consistency.

Ares Capital Core Return on Equity

Return on basic equity (Ares Capital Corp)

95% LTM payout ratio

ARCC stock is yielding 9.3% based on its regular quarterly dividend payment of $0.41 per share. BDC also currently pays an additional quarterly dividend of $0.03 per share, but this dividend is not permanent, which is why I am not including special dividends in the yield calculations.

Ares Capital saw a strong recovery in net investment income in 2021 as the investment climate improved and the LTM payout ratio was 95%.

Ares Capital Payout Ratio

The payout ratio (Table created by the author using BDC reports)

Finally the discount trade

In June, Ares Capital stock corrected and began trading at a significantly lower multiple of book value. ARCC is currently trading at 0.95x book value, which is close to the lowest P/B multiple for the stock in the past year. When a high-quality BDC like Ares Capital is trading at or below book value, I think the stock represents an extremely attractive value proposition.

ARCC price at book value
Data by YCharts

Why Ares Capital could see a drop in share price

A recession could lead to increased loan losses for the credit industry as a whole, as well as Ares Capital. Ares Capital has an excellent credit history with low loan losses, indicating that the company has strict credit risk management processes in place.

Recessions, on the other hand, typically lead to higher loan losses and more companies facing financial difficulties, which could theoretically lead to lower asset valuations. A significant increase in credit losses would almost certainly cause ARCC to trade at a lower valuation multiple.

My conclusion

Ares Capital is a high quality business development company that has covered its dividend with net investment income over the long term.

ARCC is very attractive to dividend investors due to its strong and consistent ROE performance, low historical loan losses and discount to book value.

Sallie R. Loera