Ares Capital: High Yield in BDCs

07/11/2016 8:00 am EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

One of our high-yield recommendations has been a market laggard — but it shouldn’t be; this is an opportunity to pick up 10% yield in one of the better-run business development companies (BDCs), asserts Ian Wyatt, income expert and editor of High Yield Wealth.

Ares Capital Corp. (ARCC) had a lackluster first quarter. Net investment income posted at $0.36 per share vs. $0.39 per share a year ago.

The weighted average yield on its investment portfolio dropped 40 basis points year over year to 9.2%. Net asset value per share for the quarter rose $0.04 per share to $16.50, but that’s still a $0.21 per-share year-over-year decrease.  

It’s worth noting, though, that capital markets were experiencing significant volatility in the first quarter. This was due in large part to the decline in oil and other commodity prices.

Questions about the slowing of global economic growth and general confusion regarding the direction of interest rates around the world were contributing factors.

The market has since recovered. Volatility has abated and lending activity and net investment income should improve going forward. 

Ares also announced a major acquisition in May. It will buy American Capital (ACAS), a similar BDC, in a transaction valued at $3.4 billion.

We like the acquisition. Ares is buying American Capital at a 20% discount to net asset value. The combined companies will be twice the size of the next largest competitor.

By acquiring American Capital, Ares adds scale and diversification, giving it the ability to originate larger transactions.

We’ve seen Ares successfully pull off large acquisitions in the past. A few years ago, it acquired Allied Capital and was very successful in consolidating the company and generating value out of the acquired assets.

The playbook will be much the same with American Capital. We expect Ares to rotate out of non-yielding equity investments and move into high-yield loan investments, which gives it the ability to increase its dividend over time.

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By Ian Wyatt, Editor of High Yield Wealth

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