Main Street Capital Stock: Why Your Kingdom Can Use This High-Yield Product (NYSE: MAIN)
Every household is like a mini-business, where today’s financial decisions will have repercussions for years to come. Some like to keep large cash balances while others prefer to have more as working capital.
There is no right or wrong answer when it comes to how much money you need to keep on hand, because everyone has their own version of what helps them sleep well at night. However, the following points are a good starting point:
- Your family’s spending habits: Do you tend to spend everything you have each month or do you have extra money? If you’re the type of family that tends to spend it all, it might be a good idea to keep a larger cash balance in case of unexpected expenses.
- Your investment income stream: Are you in control of your finances and able to save regularly? If so, you may not need to keep as much cash on hand, as you can easily allocate dividend income to cover recurring and unexpected costs.
This last point brings me to “safe” income investments such as Main Street Capital (NYSE: HAND), which has produced sustainable earnings despite macroeconomic adversity. This article explains why MAIN is an attractive buy after its stock price recently cooled to around $40, so let’s get started.
Main Street Capital is one of the few internally managed BDCs. It has been public since 2007, having survived 2 recessions and countless market corrections in between. It primarily focuses on investments in the lower middle market, as defined by companies with annual sales between $10 million and $150 million.
This is a competitive advantage for MAIN, given that this space is more fragmented and generally underserved, as much larger BDCs like Ares Capital (ARCC) tend to ignore this space. This results in more attractive investment returns for MAIN. MAIN also has a rather safe business model, investing primarily in senior secured debt securities as well as an equity kicker for increased upside potential.
Additionally, MAIN’s management has a significant alignment of interests with shareholders due to their strong insider participation, and its low-cost structure is another competitive advantage. This is reflected in MAIN’s operating expense ratio (calculated as total operating expenses divided by total assets) of just 1.5% over the past 12 months, the lowest in the BDC industry.
This means that MAIN does not need to “seek yield” in its investments, as it can efficiently transfer revenue dollars to its bottom line. As shown below, MAIN has delivered strong shareholder returns through a combination of net asset/share value appreciation and growing distribution.
MAIN continues to perform well, increasing its net asset value/share quarter over quarter by an impressive $0.60 to $25.89 in the first quarter. It also continues to produce the best profitability in the industry, with an annualized operating expense ratio in the first quarter of just 1.1%, lower than the aforementioned 1.5% over the past 12 months. Defaults also remain very manageable, representing only 0.6% of the total investment portfolio at fair value.
Importantly, MAIN generated record distributable net investment income of $0.77 per share, resulting in a safe dividend payout ratio of 84%. Encouragingly, MAIN has increased its regular dividend by 4.5% from the second quarter of last year, and this is on top of the two special distributions of $0.075 it has declared so far this year.
Looking ahead, MAIN is well positioned for continued growth, as it maintains a strong BBB-rated balance sheet, and management expects to maintain a safe regulatory debt-to-equity ratio in the 0.7-0.9x range. , well below 2.0x. limit. MAIN also has a thriving asset management business which is expected to see gradual growth, as management highlighted on the recent conference call:
At MS Private Loan Fund I, we continue to grow both as investor capital commitments and its investment portfolio through its co-investment activities with Main Street and MSC Income Fund in our strategy of private lending investment, and we are excited about the growing benefits we expect to receive from this relationship in 2022.
After completing our fundraising activities for the fund, we expect a total portfolio of approximately $200 million when fully invested. The continued growth and favorable performance of both funds gives us confidence that we will receive increased future contributions from our asset management businesses. The growth of our asset management business has also significantly benefited our ability to execute our private lending strategy, and we expect these benefits to increase in the future.
Risks for MAIN include the possibility of increased competition in the BDC space, which could put pressure on investment returns. Another perceived risk is MAIN’s premium to book value, with a price-to-book ratio of 1.57x. However, I don’t see this as necessarily a risk, as efficient capital operators like MAIN should be valued on their earning power rather than their book value.
This is how MAIN still produces a respectable return of 6.4% with a safe payout ratio, even when trading at a premium. On Q1 DNII/share annualization, MAIN trades at a reasonable PE ratio of just 13.2x. Analysts on the sell side have an average price target of $44.20, implying a potential total return of 15% over one year.
Key takeaway for investors
MAIN is a high-quality capital allocator that generates industry-leading returns through a combination of net asset/stock value appreciation and growing distribution. It is well positioned for further growth as it maintains a strong balance sheet and has a growing asset management business. It looks attractive after the recent dip for potentially strong growth and earnings.