Ares Capital: High Yield Opportunity

05/16/2016 8:00 am EST

Focus: STOCKS

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Our latest featured stock has been under some pressure, but nevertheless is a solid company with a very attractive yield, asserts Adrian Day, editor Global Analyst.

Ares Capital (ARCC) is a solid company; it the largest of the dividend-paying business development companies, also known as BDCs.

There have been some positive developments in the latest quarter: the net asset value increased modestly; there was improvement in the credit profile of its holdings; and it repurchased $5.5 million of its shares (though earlier in the quarter at lower prices).

The company continues to face headwinds, however. There is less deal activity in its segment throughout the industry, based on general credit and rate concerns.

For Ares, its liquidity is fairly tight, meaning it will have to undertake some exits before doing significant new purchases. And its earnings fell shy, though just by 1 cent, of its dividend.
We should note though that Ares with 75% of its dividend covered by recurring income, has a good coverage profile.

The major headwind however is the switchover from the wind-down of its old joint venture with GE Capital (which exited the credit business) to the new venture with an AIG affiliate.

The latter is in the ramp-up stage with a long way to go to fully replace the GE venture. And in the short term, it could get worse; as Ares moves investments from its books to the joint-venture, there will be an immediate decline in its earnings.

However, this will free up cash on Ares’ balance sheet and over the longer term, leverage Ares’ earnings power.

We could see weaker prices in the months ahead, so we would not addto positions right now. Nevertheless, we are definitely holding Ares, and have no problem with new investors buying.

We are experiencing a period of undervaluation because of the GE Capital saga. However, in our view, the stock is at the top of its class and sports a very high 10.1% yield.

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Adrian Day, Editor Global Analyst

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