Ares Capital Stock: Take That 8% Yield and Call It a Day (NASDAQ:ARCC)

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Inflation is often referred to as a “hidden tax” in that it eats away at a person’s purchasing power over time. That’s why it pays to invest in income-generating assets that can help you stay ahead of the game. the curve, despite recent market volatility.

This brings me to Ares Capital (NASDAQ: ARCC), which can be a good option for those seeking the shelter of a large BDC. This article highlights what makes ARCC currently worth buying for stable growth and revenue, so let’s get started.

Why ARC?

Ares Capital is a BDC that was founded 18 years ago and has since become the largest BDC in terms of asset size. It is externally managed by the highly respected Ares Management (ARES), a leading alternative asset manager operating in credit, real estate and private equity.

Currently, ARCC holds an investment portfolio of $19.5 billion at fair value, spread across 395 different holding companies. ARCC’s portfolio is well balanced, with two-thirds comprised of senior secured loans (45% first lien, 21% second lien) and the remainder comprised of higher yielding subordinated loans, preferred and common stock for an engine of growth. Notably, ARCC is also invested in another asset manager, Ivy Hill Asset Management, whose chairman is affiliated with ARCC.

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Composition of the ARCC portfolio (Publication of Q1’22 results)

ARCC continues to impress with strong results in the first quarter of 2022. This includes sequential NAV/share growth of $0.07 per share and on an annual basis from $1.56 to $19.03. ARCC saw robust deal activity as it made $2.0 billion in new investment commitments in the first quarter, including $349 million in new investment commitments to Ivy Hill Asset Management. The overall size of the portfolio has shrunk, however, as ARCC waived $2.6 billion in investment commitments.

Also encouraging, the health of the portfolio remains stable, with a weighted average rating of 3.1, unchanged from the previous quarter. The miss rate of 1.2% is also well below its 10-year average of 2.5%. Additionally, ARCC sees the benefits of rising rates, as 74% of its investment portfolio is variable rate. That helped push its cost yield up 20 basis points sequentially to 8.9% at the end of the first quarter.

Going forward, ARCC is well positioned to invest opportunistically, as it has ample liquidity consisting of $700 million in cash and cash equivalents, as well as an additional $5.3 billion in borrowing capacity in under its existing credit facilities. Moreover, it maintains a solid balance sheet with a debt ratio of 1.13x, below the 1.26x at the end of 2021 and well below the regulatory limit of 2.0x.

ARCC is also expected to see significant growth from its recently announced acquisition of another asset manager with a $2.4 billion portfolio, as management noted on the recent conference call:

Last night, Ares management announced the acquisition of the direct lending portfolio of Analog Capital Management, which has decided to exit its direct lending strategy. The overall $2.4 billion portfolio is made up of US senior secured loans to more than 40 companies backed by numerous private equity sponsors.

In terms of specific impacts on ARCC, approximately half of this $2.4 billion portfolio will be funded by both ARCC and Ivy Hill, with a significant portion of the loans being purchased by Ivy Hill, given of the senior orientation of this portfolio. We believe one of the benefits of this transaction is to further support Ivy Hill’s growth. We expect that revenue growth from these investments may ultimately support additional dividends from Ivy Hill to ARCC following the closing of the transaction, which is expected to occur at the end of the second quarter.

Risks to ARCC include its external management structure, which could lead to conflicts of interest. Moreover, ARCC’s regular dividend of $0.42 per share is barely covered by its first quarter net profit of $0.43 per share. That’s not too much of a surprise, though, as the ARCC has typically had a payout rate in the 95-100% range in recent years.

I continue to see value for ARCC at the current price of $20.80 with a price-to-book ratio of 1.09x. The premium to book value is deserved, given the company’s track record of value creation. Analysts on the sell side have a consensus buy rating with an average price target of $22.89. This translates to a potential total return of 18% over one year, including dividends, which could help investors stay ahead of inflation.

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ARCC price to book (Looking for Alpha)

Key takeaway for investors

I continue to see value in ARCC at the current price. The company is well positioned to take advantage of market opportunities and its recent acquisition should help support its future growth.

The ARCC also offers a generous dividend yield that is ahead of inflation, which could help investors stay ahead of rising prices. With a potential one-year return of 18%, ARCC could be an attractive stock for investors looking for stable growth.

Sallie R. Loera