Ares Capital (ARCC) is the largest, and one of the most conservative of the Business Development Companies (BDCs), which lend money to small and medium sized companies, and, like REITs, pass through most of their net income to shareholders, notes Adrian Day, editor of Global Analyst.

It continues to do well, recently reporting its second-highest earnings quarter in his history and a record quarter for originations. Loans on non-accrual remain less than 3%, at cost, almost back to pre-covid levels. 

The company reports an increase in queries for loans, particularly from larger companies who see the advantages of private loans (as opposed to bank loans) in speedier and more certain closing as well as flexibility on conditions. Ares, being the largest BDC, is gaining share because of its size.

The company continues to have significant spill-over income, currently equivalent to about three quarters worth of dividends. Though this does not have to be distributed, it will likely lead to a special distribution as it has paid in previous years.

Even without these occasional special distributions, and despite very strong stock performance, the yield remains high, at 7.8%, and is now fully covered from net income once again after a brief and minor “miss” during the depths of Covid-19.

The risk would be a long, severe recession which would affect the ability of its portfolio companies to service their debt. Given that Ares sailed through the covid lockdown period — and given the profile of the companies to which it lends (lightly leveraged and non-cyclical businesses) — and given the cushion of spill-over income, we think this is a modest risk. It might affect the stock price but would be unlikely to affect the dividend.

A stock market decline would also affect the valuations on its private companies and its ability to sell companies at today’s high prices. Meanwhile, the balance sheet is very strong with a large cash reserve and total liquidity of over $7 billion. Ares is a solid holding for income-oriented investors. If you do not own the shares, you can buy for the above-average yield.

Subscribe to Adrian Day's Global Analyst here…