Top Picks 2016: Ares Capital

01/11/2016 7:00 am EST

Focus: INCOME

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Our Top Pick for income investors for 2016 is the largest of the dividend-paying Business Development Companies, with a market-cap over $4.5 billion, explains Adrian Day, editor Global Analyst.

Business Development Companies—or BDCs—are companies that lend money to small and medium-sized businesses and pass-through net income to shareholders (just like REITs), so the dividends tend to be high.

The shares of Ares Capital (ARCC) have been weak for both sector and company-specific reasons.  BDCs are weak because of concerns about higher interest rates, but these concerns are misplaced. 

Most of the companies, including Ares, have the majority of their debt investments structured with floating rates, while their corporate debt is at fixed rates.

Thus, higher rates would increase the interest payments received and widen the spread (while unlikely to be sufficient to hurt the small businesses in which they invest).

Ares has an added problem: it has a large joint venture with GE Capital, and General Electric (GE) is exiting the finance business, leading to concerns about it selling existing loans rapidly, at losses.

This is also misplaced. The loss of revenue from this joint venture is likely to be only a couple of cents per share, while Ares is working hard to replace the lost revenue. 

The current yield on Ares is over 10.5%, fully covered by net investment income.

Moreover, Ares has some excess revenue from previous years it is carrying forward and can distribute should there be any short-fall in income to pay the dividend. The stock tends to be volatile, so buy on dips.

Subscribe to Adrian Day's Global Analyst here…

Click Here for More 2016 Top Stock Picks

Related Articles on INCOME