Ares Capital (ARCC) reported weaker earnings for the first quarter, due to lower origination fees and modest balance sheet deleveraging. But most BDCs, including Ares, have important characteristics that distinguish them from banks, and it can be bought here for long-term investors looking for yield, writes Adrian Day, editor of The Global Analyst.
Ares stock, along with other BDCs, fell from earlier highs amid the banking crisis in March. But that’s where the differences come in. Most importantly, BDCs employ far less leverage, and they match duration on their assets and liabilities (what an idea!)
Most of their debt also tends to be fixed rate while their loans are mostly variable. So, while the stocks will tend to be volatile, the better companies are well-positioned to survive and even profit from an economic downturn.
In the most recent quarter, credit metrics at Ares worsened slightly, continuing a trend of the last few quarter. But they remain above the company’s 15-year average and the BDC sector’s average.
It was not all bad (modestly bad), either. Core earnings (from loan income) were up 36% year-on-year, driven by higher interest rates on new investments. Earnings remain comfortably in excess of the dividend. The company’s NAV increased, to $18.45 a share, while the Return on Equity remains high, increasing to 12.7%.
After the deleveraging, the debt-to-equity ratio is below 1.1 times, very low, giving the company lots of dry powder for new investments. Going forward, the company expects origination fees to stay low in what it sees as a slow transaction environment. The first quarter of the year is usually the slowest, but this one was slower than normal.
However, the company still sees lots of potential deals; the number it looked at this past quarter was up by 14%. Longer term, the turmoil in the banking sector means banks are constrained in making new loans, to the benefit of the BDCs.
Ares also maintained its quarterly dividend–equating to over 10% on an annual basis. It also has $1.19 per share in spillover income, the equivalent of 2.5 times its regular dividend payout, providing ample cushion to supplement any weak quarters. It is trading at a 5% discount to NAV, and the company has a share buyback program in place for use when the discount widens too much.
Recommended Action: Buy ARCC.
