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Adrian Day Banks on BDCs for Attractive Yields

09/27/2019 5:00 am EST

Focus: FINANCIALS

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Adrian Day is an internationally-known investing expert with a noted expertise in the speciality financing sector known as business development companies. The editor of Global Analyst reviews two of his long-term holdings, which he notes sport very attractive yields.

Ares Capital (ARCC) is in a strong position to sustain its returns, currently earning over 11% on investments. The company is one of highest quality BDCs, with the added benefit of scale.

It has strong dividend coverage, and room to increase leverage towards it target level of 0.9 to 1.25x. We expect the increase to be slow without any diminution of lending standards.

The stock has recovered from its ACAS-purchase slump. Indeed, it is trading at a post credit crisis high. Although Ares is now trading at a premium to the BDC sector, other high-quality BDCs are trading at higher valuations. It is worth paying up for such high quality. Insiders agree, and there has been widespread insider buying in recent months.

The fee waiver that Ares introduced following the ACAS acquisition will come to end after one more quarter, but given that NOI is comfortably above the dividend, this will occur without any bumps in dividend coverage.

Trading just over book, and yielding 8.5% — both at the high end of recent valuation metrics — we are holding, but comfortably so. A better-than 8% yield, well covered, from a high-quality company and with room to grow, is well worth holding. We would buy more on a pullback.

Gladstone Investment (GAIN) continues to report solid operating results, with another increase in net investment income, which continues to exceed its regular dividend.

There is also 11 cents a share accrued, so the dividend looks very secure. However, exits continue to be greater than new investments, and there was a small slip in Net Asset Value. With the recent decision to keep back some income, liquidity is strong.

Gladstone is trading just under book. On its monthly dividend, the yield is under 7%, but Gladstone—unlike most BDCs—has about 30% of its investments in equity, and it pays a semi-annual distribution from net capital gains.

The amount varies of course, but including those additional distributions, the yield is well over 8%. Valuations are at the low end of the five-year range, as with Ares, but with a second dividend and room to grow, we are holding GAIN and would buy again on a pullback.

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