Ares Capital Stock: slip and I buy this BDC at 8% yield

Adrian Vidal

Ares Capital Shares (NASDAQ: ARCC) slipped more than -3% on 7/29 after news broke that the ARCC would price 8 million shares in a public offering. The 8 million share offering came days after ARCC beat second-quarter earnings estimates on EPS and investment income and rewarded shareholders with a Quarterly dividend increase of 2.4%. ARCC is the largest BDC listed on the stock exchange by net assets and market capitalization, and plays an important role as one of the largest direct lenders in the United States to private or public American companies with a market capitalization of less than $250 million. Is the ARCC an investment that will gain enormous notoriety? Will the ARCC break out and generate massive amounts of capital appreciation? ARCC isn’t flashy, it won’t have the same tailwind potential as some tech companies. From a capital appreciation perspective, an S&P index fund is likely to appreciate more over an extended period. ARCC is an income investment that is probably only attractive to investors looking for above average income generation potential. I like ARCC for under $20 and am looking to buy it as it slips.

Shareholder value

Ares Capital

The good news of T2

In the second quarter of 2022, the ARCC committed approximately $3.1 billion in new investments, including $570 million in new investment commitments to IHAM, which have already been funded with 2.9 billions of dollars of capital. The $3.1 billion in new investments included 21 new portfolio companies and 31 existing portfolio companies. These additional investments consist of 71% Senior Senior Loans, 1% Second Lien Secured Loans, 1% Subordinated Certificates of the Senior Direct Lending Program (the “SDLP”), 3% Subordinated Senior Loans , 3% preferred stock, 18% IHAM and 3% were in other stocks. Of these, 89% were floating rate debt securities, of which 94% contained interest rate floors.

Wallet

Ares Capital

In the second quarter, ARCC generated $0.46 in EPS, a beat of $0.02 and produced $479 million in investment income, a beat of $12.79 million, up 4, 4% YoY. ARCC has been focused on securing deals with larger companies in recent years, which has helped during the downturn as ARCC’s portfolio weighted average EBITDA reached $179 million. This is more than 2 times compared to 2017. ARCC believes that the continued increase in market interest rates presents a potential opportunity for growth in its core earnings. This is due to the large floating rate loan portfolio, which is funded primarily by low cost, fixed rate and unsecured sources of funding. The ARCC expects further rate hikes to push its core quarterly earnings well above their Q2 level.

Portfolio EBITDA

Ares Capital

ARCC’s total portfolio at fair value at the end of the second quarter was $21.2 billion and its total assets were $21.8 billion. The weighted average return on ARCC’s debt and other income-producing securities at amortized cost was 9.5%, and the weighted average return on total investments at amortized cost was 8.7%. Total investment return at the end of the second quarter increased by approximately 60 basis points compared to the first quarter. These numbers look enticing to me as the ARCC should benefit from the rate hike, as it will theoretically be correlated with positive impacts on net interest income in the third quarter.

The latest dividend increase is a continuation of a long-standing practice of ARCC

ARCC has a long history of paying dividends, with 2005 being its first full year of paying dividends. Since inception, ARCC has increased its quarterly dividend by 48.28%. ARCC’s core earnings and net realized gains boosted its dividend growth, and the rising rate environment helped ARCC achieve another dividend increase. ARCC’s dividend track record is unique and income investors should take these statistics into consideration. ARCC has just provided its 2nd quarterly dividend increase in the past 12 months, which is its 3rd increase in the past 6 quarters and its 53rd consecutive quarter of unchanged or growing dividends.

Dividends

Ares Capital

The graph above illustrates all of ARCC’s dividends since the third quarter of 2018. Throughout 2019, ARCC paid 4 special dividends in addition to its regular quarterly dividend. This is another aspect that distinguishes ARCC from other BDCs, as they continuously generate indirect income. ARCC has estimated that its spinoff revenue from 2021 to 2022 will be approximately $694 million, or $1.41 per share. Generating undistributed indirect income helps sustain ARCC’s dividend through fluctuating economic and market cycles. Q3 will now be the 3rd consecutive quarter that a special dividend will be declared in addition to the regular quarterly dividend.

ARCC went public through an IPO at $15 a share since the fall of 2004 and appreciated 29.27%. If this statistic were given to investors looking for capital appreciation, they would look at you like you’ve lost your mind. As I stated at the beginning of this article, I consider the ARCC to be an income vehicle. Including the Q3 2022 dividend, ARCC will have paid $27.39 in dividends since its IPO, or 182.6% of its original value. When I look at income investments, I just want them to trade sideways, and if they’re generating a little capital appreciation, that’s an added bonus for me. The main focus is income, and the ARCC generates income in spades. Its next ex-dividend date is 9/14/22 with a payout date of 9/30/22. ARCC’s dividend track record is difficult to replicate, and the special dividends are an added bonus on top of the 53 consecutive quarters of unchanged or growing dividends.

How the 8 million share offering could be used

The market didn’t seem to like the 8 million shares ARCC is selling in the public offering. The ARCC has granted the underwriters an option to purchase up to 1,200,000 additional common shares, and the offering is expected to close on 08/02/22. ARCC expects to use the proceeds to repay certain outstanding debts under its credit facilities. ARCC may re-borrow under its credit facilities for general corporate purposes, which includes investing in portfolio companies in accordance with its investment objective.

Here is my opinion on the offer. I hate stock dilution because it decreases the equity my stocks represent. When public offerings occur, investors should investigate the use of the proceeds and whether the management team has a good track record of creating shareholder value.

My view on this is that ARCC’s management team has generated shareholder value and has a long track record of generating core earnings and growing net gains from its portfolio. . Due to my background, I am more than willing to put aside my personal sentiment on dilution, as ARCC has demonstrated fiscal responsibility over the years. Each investor should review the offer and see if they agree with how the proceeds will be allocated.

Basic income

Ares Capital

Conclusion

ARCC is for me a pure income investment to which I will add. I don’t expect ARCC to generate large amounts of capital appreciation, but I do expect it to continue to generate large amounts of income from its quarterly dividend. Its dividend payout history is hard to argue with, and the 3rd consecutive special dividend is the icing on the cake. The offer of 8 million shares created a sell-off, which may be extended into the next trading session. If you’re an income investor, I believe ARCC is the creme de la creme of BDCs, and that’s an 8% return you can count on. Investors should review the public offering and see if they agree with how the proceeds will be allocated. I think ARCC has done a fantastic job creating value in the past, and the rising rate environment could help drive additional growth across its portfolio.

Sallie R. Loera