Ares Capital: Best of the BDCs

01/30/2017 9:00 am EST


Adrian Day

Chairman and CEO, Adrian Day Asset Management

Ares Capital (ARCC) is not only by far the largest BDCs — Business Development Companies — but also one of the best and one of the most conservative, suggests Adrian Day, editor of Global Analyst.

With about $12 billion in investment assets, Ares Capital has a strong balance sheet, with sizeable liquidity, and one of the top platforms for new investments.

The growth outlook remains positive. And most loans have floating rates, so the company’s income will increase as rates move up.

The acquisition of American Capital (ACAS) was by far the largest-ever M&A transaction in the BDC space. ACAS’s portfolio was relatively low yielding (about 7.5%) with many equity investments.

Although Ares will look to monetize some of these, it won’t happen overnight; ACAS doubtless already sold much of the low-hanging fruit.

So the question has been raised whether Ares can continue to pay the current dividend after the ACAS acquisition.

We believe it can. The equity dilution is minimal and Ares management has waived $100 million in fees over the next 10 quarter. And we expect earnings growth.

So we certainly believe Ares can continue with its current dividend payout, even if it has to subsidize the dividend for a quarter or two. The current dividend is 38 cents per share.

Ares’ stock has moved up, from a level just over $15 for much of the fall, and the yield has just edged below 9%. While lower than it has been for the last couple of years, it is still a very attractive yield and well in-line with the stock’s historical yield.

Among the major externally managed BDCs, Ares has the highest returns and currently the lowest valuation. After the recent run — it was trading under $15.60 less than a month ago — the stock is now just above book value.

Again, this is higher than it has traded for the last couple of years, but lower than in the 2010-2014 timeframe. In the immediate term, the stock could continue to move now the acquisition has been completed, given the large short interest.

As often happens, arbitragers and others sell an acquiring company’s stock (or even sell short) and buy the target. Once the acquisition is complete, these positions need to be unwound.

Beyond that, for income-oriented investors who do not already own the stock, I would rate this a good time to buy. If you are looking to add to existing positions, I would look for any pullbacks in the sector or broad stock market.

But make no mistake: buying a 9% yield from a substantial, conservative, growing company is a solid buy for long-term investors.

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