Main Street Capital Corporation (MAIN) — which stands apart from the rest of the business development company crowd — is an income stock for all seasons, recalls Tim Plaehn, income specialist and editor of The Dividend Hunter.
MAIN has been recommended in our portfolio stock since our second monthly issue, published in July 2014. Over the seven-plus years since (through September 2022), the monthly dividend has increased eleven times, from $0.165 per share to the current $0.22. That works out to total growth of 33%.
Main Street Capital is set up as a business development company (BDC). Legally, a BDC is a closed-end investment company, similar to closed-end mutual funds (CEF). The difference is that a CEF owns stock shares, bonds, and other marketable securities, while a BDC makes direct investments in its client companies.
A BDC will have hundreds of individual investments in order to spread the risk across many small companies. The client companies of a BDC will be corporations that are too small or too new to be able to issue stock or bonds into the publicly traded markets.
As a risk control factor, rules limit BDCs to no more than two times their equity in leverage. This restriction means that if a BDC has $500 million of equity raised from selling shares, it can borrow another $1 billion. The company can then make $1.5 billion of loans or equity investments.
Since its 2007 IPO, the company has tripled the average total returns of its BDC peers. Here is a list of some of the reasons why Main Street Capital stands apart from its peers in the industry:
- Main Street Capital is internally managed, with insiders owning over 2.8 million shares. Co-founder and chairman Vince Foster is the single largest individual shareholder.
- Main Street is the most conservatively managed BDC in the industry and holds an investment-grade BBB credit rating — rare among the BDC crowd. This allows the company to borrow at a much lower cost of capital than most other BDCs.
- The operating, admin, and management costs are 1.1% of assets compared to over 3% for the average BDC and 2.5% for commercial banks.
- Net debt is just 0.69 times company equity, well below the 2.0 times maximum set by law.
- The share price is about 1.7 times the book or net asset value (NAV).
Main Street Capital uses a three-tier approach to its portfolio, which allows the company to generate a high level of interest income and capital gains from equity investments. In the middle market, Main Street provides debt financing to companies with stable finances and a low risk of default. Main Street currently has 34 middle-market clients with an average loan of $12.3 million.
The largest portion of its portfolio is lower middle market (LMM), where the company takes equity stakes along with providing debt financing. Equity offers a significant boost to the total returns generated. Lower middle-market companies are smaller than the typical BDC client and have annual revenues between $10 and $150 million.
The equity position gives the company an average of 41% ownership of its client companies. LMM makes up 49% of the total investment portfolio; the investments are split into two-thirds high-yield loans and one-third in portfolio company equity.
In recent years, Main Street has been growing what it calls its Private Loan Portfolio. These are loans originated through strategic relationships with other investment funds on a collaborative basis, often referred to in the debt markets as "club deals."
The private loan portfolio makes up 29% (68 loans for $744 million) of the overall MAIN portfolio and carries an average yield of 8.6%. The loans have floating interest rates and benefit from lower overhead costs.
Main Street Capital increased its monthly dividend rate for the 2023 first quarter. The new dividend in January, February, and March will be $0.225 per share. This represents a 2.3% increase over the current dividend — up 4.7% for the year. MAIN also declared a $0.10 per share supplemental dividend, to be paid December 28. (For full disclosure, Tim Plaehn holds a long position in MAIN.)