Ares Capital: A 9.2% Yielding BDC Cash Cow

seekingalpha05-03

Ares Capital Corporation reported strong quarterly earnings, comfortably covering its dividend and seeing an increase in net asset value.The company completed a significant number of new originations ...

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The BDC just reported quarterly earnings for 1Q24 and Ares Capital comfortably covered its $0.48 per share per quarter dividend with net investment income and the company's net asset value rose QoQ. Furthermore, the non-accrual remained well below my critical personal assessment level of 1.0% (though it increased slightly QoQ) and the business development completed a boatload of new originations in the first quarter. Ares Capital remains a top income investment for me with a 4% portfolio allocation, and I don't see any meaningful risks as far as the dividend is concerned. My Rating History My stock classification for Ares Capital was Buy in February 2024, and I continue to rate the business development company as a 'Buy' after the company's 1Q24 results presentation. Ares Capital is delivering robust net investment income from a First Lien-centric investment portfolio, and the BDC's valuation is sensible given the quality of its portfolio and excess dividend coverage. Taking into account that the non-accrual ratio remains well below 1%, I think Ares Capital should be an anchor investment in an income-minded portfolio for passive income investors. Portfolio Review, Originations And Non-Accrual Trend Ares Capital's investment portfolio as of March 31, 2024, included 510 different portfolio companies which had an accumulative investment value of $23.1 billion, up 1.1% QoQ. Ares Capital's Portfolio continues to be dominated by First Lien and Second Lien Senior Secured Loans, which accounted for a combined 59% of the company's total investments in 1Q24. The business development company completed $140 million in net fundings in the first quarter which was the fourth consecutive quarter of positive net fundings, allowing the BDC to grow its portfolio. Moving forward, a decline in short-term interest rates is probably going to be the biggest catalyst for Ares Capital's portfolio growth, as they would likely spur new First Lien and non-First Lien originations for the BDC. Investment Portfolio Overview (Ares Capital) The majority of (gross) commitments were once again made in the First Lien category, which represents the highest quality form of debt that a business development company can invest money into. Because Ares Capital reinvested so much money into First Liens in particular, the percentage of First Liens rose from 44% in 4Q23 to 46% in 1Q24, resulting in slightly higher portfolio quality. Portfolio Activity (Ares Capital) High-quality business development companies have two defining characteristics:  They have consistent excess dividend coverage; and They have top credit quality, usually signified with a low non-accrual ratio.  I will discuss Ares Capital's excess dividend coverage a little later, and now take a look at the company's underlying credit quality. Ares Capital's non-accrual ratio, which measures the amount of impaired loans in the portfolio and whose trend gives an indication about future dividend risk, edged up slightly QoQ to 0.7%, based on fair value. This non-accrual ratio represented an investment value of $168 million (also based on fair value). Non-Accrual Ratio (Ares Capital) Ares Capital Continues To Offer A Well-Covered Dividend Passive income investors that are looking for a high-yielding, well-managed business development company, in my view, can do nothing wrong with Ares Capital. The BDC earned $0.55 per share net investment income in the first quarter and $2.24 in the last twelve months. The dividend coverage, based on NII, was 115% in 1Q24, which signified a QoQ decline of 10 percentage points, but the business development company's dividend coverage metrics still look very healthy overall. In the last twelve months, Ares Capital only paid out 86% of its net investment income, leading to a dividend coverage ratio of 117%. Dividend (Author Created Table Using Company Supplements) Ares Capital Is Still Cheap Business development companies tend to trade around net asset value, which reflects the cumulative value of its underlying debt and equity investments. Some BDCs, like Main Street Capital (MAIN), sell at rather high NAV multiples, but most BDCs tend to sell at or near net asset value. In the case of Ares Capital, the BDC is presently selling at a 7% premium to its last net asset value of $19.53. As usual, I consider a BDC's net asset value to be representative of its intrinsic value. Ares Capital's net asset value rose 1.5% QoQ due to new originations and the valuation multiple compares favorably against other business development companies, including Blue Owl Capital Corporation (OBDC), Goldman Sachs BDC (GSBD), and Golub Capital BDC (GBDC). All of these BDCs are highly regarded, First Lien-focused business development companies and offer passive income investors comparable stock yields. Why The Investment Thesis Might Disappoint Dividend coverage and non-accruals are important trend indicators as far as Ares Capital's dividend continuity is concerned. I don't see a major risk for the dividend as of right now, but things might change moving forward, particularly if the U.S. economy were to fall into a recession, a time during which loan defaults tend to rise. Presently, Ares Capital's portfolio quality looks robust, but passive income investors would want to pay close attention to the non-accrual trend moving forward in order to detect heightening dividend risks early. My Conclusion Ares Capital is a well-managed, 9.2% yielding cash cow that produced once again very predictable and stable net investment income results, robust dividend coverage based on net investment income, and the BDC's net asset value rose QoQ. Furthermore, Ares Capital maintained overall very solid credit quality, with a non-accrual ratio of only 0.7%. I think that Ares Capital's long streak of dividend payments as well as 115% dividend coverage ratio strongly suggest that the BDC will continue to pay $0.48 per share per quarter moving forward.  The valuation is also not too stretched, in my view, when taking into account the underlying quality of Ares Capital's First Lien-centric investment portfolio. Buy.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2432940579"}