Worshiping Ares Capital Stock Financial Vision: Higher Dividends Are Coming (NASDAQ:ARCC)

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Ares Capital (NASDAQ: ARCC) posted significantly higher core EPS and net investment income per share quarter-over-quarter. Both exceeded estimates. The high story does not end with this bullish report for this trade development company (“BDC”). The BDC lends at significant premiums to middle market companies. So take the man-a-lift, one at a time, please, and let’s head to the set and see the whole kit and kaboodle.

The quarterly report

Benefits, both short-term and long-term, are showing up at Ares, but before we head into the panorama, let’s stop at the latest results for a review. Highlights of the report include:

  • Basic EPS of $0.46 up 10% quarter over quarter.
  • Net investment per share at $0.52.
  • NAV of $18.81 slightly lower due to unrealized losses from wider credit spreads.
  • The largest stake is only 0.2% (diversification).
  • The average EBIDTA of his holdings is now $179.
  • Limited to 5% to 10% in the high risk category.
  • Weighted average return at 9.5%, up 60 basis points quarter-on-quarter.
  • $4.6 billion in cash.
  • Leverage at 1.25 up significantly from 1.06 at the end of March.
  • $3.1 billion in new investments in the quarter, most of which were top tier.
  • Average investment rating of 3.2.
  • Non-bookings reached 1.6%, compared to 1.2% last quarter, due to additional investment.

Ares has done really well in an uncertain market. Management also clarified that more and stronger performances can be expected.

A long-term vision from a distance

Once the quarterly review is complete, let’s cross the plateau to the edge for the panoramic view. Management noted, “We are becoming increasingly selective with our core deal flow to focus on the highest quality investments and to generate better pricing in terms.” In times of uncertainty, deals can and do get cheaper. Our skills don’t lend themselves to an estimate, but that’s a long-term positive.

Perhaps the most important announcement offered on the call is in this insightful statement. Penni Roll, Ares CFO, said:

Before I conclude, I want to talk about our undistributed taxable income and our dividends. We currently estimate that our overhead revenue from 2021 to 2022 will be approximately $694 million or $1.41 per share. We believe that having strong and significant retained earnings supports our objective of maintaining a stable dividend through market cycles. . . .”

The company does not pay out all of its profits, but rather provides a deferral for future rainy days.

Visible Opportunities

As we watch the stage show for more details, the volatile environment creates market opportunities, opportunities that are not present in other climates. Management noted that “leverage guidance markets are experiencing significant spread widening, low secondary liquidity and minimal primary issuance” with large banks working on unsold committed funding, many of which are experiencing significant losses. Ares’ approach includes building liquidity for the obvious and beneficial addition of new, discounted loans to existing and new borrowers. Management is clearly happy with this volatile environment for its longer-term growth.

Immersed in the beauty of investing

Again, management discussed the value of rising market interest rates and other natural circumstances created when interest rates rise. A summary of a few follows:

  • Increasing market rates by 100 basis points increases basic earnings by $0.08 per quarter. (The company believes larger increases will appear in Q3 and beyond.)
  • A 150 basis point increase likely raises “a weighted average portfolio interest coverage ratio of about two times.”
  • Since the effect of the base rate was not fully realized in the 2nd quarter, this quarter should have actually been higher by $0.05 or approximately $0.51.

Ryan Lynch of KBW asked:

“…when I look at base revenue…and potential increases going forward…revenue seems to be much higher than combined when you kind of look at 2023 revenue potential…can remind us of your thoughts on future dividend policies?

deVeer answered simply (emphasis added):

“Looking ahead, we think we have a great positive earnings trajectory here. with a much, much higher base rate. . . yes, we are reaping very easy gains in the future. . . . but we were very confident in our ability to increase the dividend this quarter. And I’m going to couple that by saying we’ve also built quite a significant amount of indirect revenue, as you know for the business. . . . So we’re happy with the earnings trajectory, and we’re happy with the dividend as it is today and potentially growing from here.”

The management’s conservative analysis of its earnings projections offers investors some thoughts to consider. Adding some of the delicious edge observations, Ares could earn between $0.54 and $0.60. (We’re not sure if the missing 2Q earnings should be directly added to the likely 3Q increase.) This excludes the carryover from last year. We have included a slide from the last quarter presentation showing the dividend record showing its stability.

Dividend history

Ares Capital

Dividend increases are coming. How much is in management’s sleight of hand? What will appear in the sleight of hand is still a guess. What we believe is that since most of the increase comes from higher fixed interest rates, most of the dividend increases will be administered through special offers. It looks like at least $0.50 per quarter is gradually coming in over the next few quarters.

Risk and investment

Risks should be considered alongside observed growth with a holistic view. First, we looked at the corporate debt structure shown below. In 2023, the first refinancing appears, which continues in increasing amounts until 2026. The effect that this restructuring could have on profits is not entirely known. But, Fed Chairman Powell, in his remarks at the Jackson Hole convention, made it clear that fighting inflation trumps economic growth. The high interest rates will be there for a while.

Debt structure

Ares Capital

Not to mention, Ares and its management are also creating the usual opportunities out of the current volatility. Also, keep in mind that this isn’t the company’s first encounter with a volatile interest rate market; he successfully navigated the previous one. The company generates cash, lots of cash and will be compelled over time to increase its returns for investors, widening the smiles on our faces. The view at the edge is fascinating, brilliant and inviting. Adding or entering a position on a weakness seems like a lucrative action.

Sallie R. Loera