Main Street Capital Stock: 7% monthly dividend yield on sale
Main Street Capital (NYSE: HAND) is a business development company that offers high returns paid in monthly installments. The company is well managed, has an excellent track record and although it is not ultra-cheap, its valuation has fallen over the past two months, improving the value proposition.
Main Street Capital Insight
MAIN is an internally managed business development firm managing nearly $6 billion in capital. Its market capitalization today is $3 billion, while its book value is $1.8 billion. Internal management is generally positive for BDCs, REITs, etc., as the interests of management and shareholders are better aligned compared to structures where the entity is externally managed.
Most of Main Street Capital’s investments are in the lower middle market, which consists of companies generating approximately $10 million to $150 million in revenue per year. Access to capital is not easy for these companies, as they are often too small to do what would be possible for (much) larger companies, i.e. directly access the bond or shares. MAIN offers a range of financing solutions for these businesses, including senior debt and senior secured debt, as well as equity financing. MAIN’s equity investments are made in companies MAIN knows well because of established business relationships, which reduces the risks of Main Street Capital’s equity portfolio. MAIN’s fixed-rate investments make up the majority of its asset base and investment income, but dividends and capital gains from its stock portfolio contribute about 20% of the company’s income. business most years.
Main Street Capital’s balance sheet is strong. The company is rated BBB- by Standard & Poor’s. Its investment grade rating allows MAIN to access the debt markets on favorable terms, resulting in long average maturities and attractive yields:
With yields as low as 3% for fixed notes maturing in four years, Main Street Capital can capture very attractive spreads, given that it lends money at much higher rates. The weighted average effective yield of its private loan portfolio is, for example, 8.2%.
MAIN’s larger than average size allows the company to operate very efficiently. Since some business expenses are fixed or semi-fixed, for example a large portion of general and administrative costs, scale comes with improved efficiency. Compared to its peers, MAIN works quite efficiently:
With operating expenses of approximately 1.5% relative to assets of the entire company, Main Street Capital’s operating expenses are about half that of its BDC counterparts. I believe that excluding stock-based compensation is not the best way to look at expenses. Even though SBC is a non-cash item, there is a real impact on shareholders as it gets diluted over time. Yet even when we include SBC expenses, operating expenses are at an attractive level compared to how other businesses in the financial sector, including commercial banks, operate.
Solid Main Street track record and appraisal
Main Street Capital’s experienced management and efficient cost structure have allowed the company to grow its business at an unstoppable pace in the past. It is important to note that this is also true per share. Some BDCs generate significant business growth, but do so by issuing shares at a rapid rate, which is why their net asset value per share is not growing at an attractive rate. In some cases, BDCs even see their net asset value per share decline over time, despite the growth in business volume. This is primarily a problem with externally managed BDCs, as managers are not necessarily well aligned with investors in these cases. But when it comes to Main Street Capital, investors have benefited from the company’s growth since its IPO in 2007:
Since the IPO in 2007, book value has roughly doubled from $13 per share to over $25 per share. This was possible despite large dividend payouts during this period, as we will see shortly. In the chart above, we see two periods where book value declined significantly. This includes the financial crisis that followed the real estate crash and the recent COVID pandemic. At that time, the book value decreased significantly, due to the loss of value of equity investments, at least temporarily. The increase in provisions due to higher default risks also plays a role. That being said, the book value hasn’t fallen much, and we also see that there has been a strong recovery in the book value both times. Recently, the book value per share has reached new all-time highs, which shows that the pandemic has not damaged the company in a more lasting way. Instead, he’s stronger than ever.
Appreciation in book value should result in stock price gains over time, as BDCs are generally valued based on their book value. According to BDC Quality, book value multiples vary from company to company. But looking at an individual’s historical valuation gives us an indication of whether the company is attractively priced or not. Main Street Capital, due to its strong track record and high returns to net asset value, typically trades at a significant premium to its book value.
In the chart above, we see that Main Street Capital is trading today at 1.67 times its book value. This is clearly one of the lowest valuations at which BDC has traded in the past year, as its multiple of book value at times exceeded 1.90. We also see the graphs of the 3-year and 5-year median book value multiples. These are both slightly ahead of the current valuation. One could therefore say that Main Street Capital is relatively well valued, even potentially slightly undervalued today. Main Street Capital shares are a better buy today compared to almost any time last year, with the exception of a short stretch in March when its shares fell as low as $40.
MAIN Stock – Monthly Dividends and High Yield
The capital appreciation of BDCs is nice, but most investors buy them for the income they provide. As yield vehicles, their dividends are understandably a very important driver of total returns, and the sole reason for holding these investments for some.
Main Street Capital has a very compelling dividend history, as we can see in the next slide:
The company has never cut its dividend, not even during the financial crisis or the pandemic. Instead, dividends have either been kept flat or increased every year since the company went public. Overall, the company has increased its dividend by 95% since its IPO, representing a growth rate of 5%.
At current prices, the regular dividend of $0.215 per share per month translates to a dividend yield of 6.2%. Since MAIN also pays out special dividends from time to time, such as the $0.075 excess payment in March, the dividend yield on a rolling basis is even higher at 6.8%. A dividend yield of almost 7%, combined with an annual dividend growth of 5%, is quite attractive. All other things being equal, one would expect annual returns of around 12% from this combination. It is of course possible that future dividend growth will be more moderate. But even if Main Street Capital’s dividend grows at only half the historic rate going forward, or 2.5% per year, the combination with a dividend yield of 6.8% could lead to annual returns of l order of 9%. For a well-managed, reliable income investment, that’s attractive, I think. Monthly dividend payments don’t automatically make the company a great investment, but monthly dividends can be an added bonus. Those who live off their dividends get more regular and easily predictable income, and those who don’t spend their dividends can reinvest them more regularly.
Main Street Capital is a quality business development company with a compelling track record. Its current dividend yield is attractive and the stocks look fairly valued, and potentially even slightly undervalued, on a price-to-book basis.
Rising interest rates are not a headwind for MAIN, but rather a small tailwind. The company has forecast a $0.12 increase in investment income per share if the interest rate increases by 150 basis points. A 100 basis point increase would result in a tailwind of $0.07 per share for MAIN’s investment income. The stock’s pullback over the past few months could therefore present an attractive buying opportunity for this quality income stock.