Unlock Up To 9% Yield For Wherever Interest Rates Land

seekingalpha08-27

Uncertainty surrounds interest rate direction for the rest of the year, influenced by conflicting economic indicators and consumer sentiment.I highlight 2 stocks that are well-positioned for wherever ...

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First, there was the July Jobs report, which indicated that the unemployment rate shot up to 4.3%, a three-year high, suggesting the need for a rate cut. That was then followed by a strong retail report, indicating that consumers remain confident, which suggests continued potential for elevated rates. Then couple that with the fact that 59% of Americans wrongly think the U.S. is in a recession, and you can surmise that where interest rates will and by year-end is anybody's guess. It's no wonder that economics is considered to be a quasi-science due to the myriad of variables out there, not least of which include the emotional behavior of consumers that's hard to forecast. This brings me to the following 2 picks, both of which, I believe, are well positioned for whichever direction inflation and interest rates may go, primarily due to their business models and financial flexibility. Both carry competitive advantages and offer investors well-above average yields, so let's get started! #1: Capital Southwest Capital Southwest (CSWC) is one of a handful of internally managed BDCs alongside peers Hercules Capital, Inc. (HTGC), Trinity Capital Inc. (TRIN), and Main Street Capital (MAIN). True to its form, CSWC benefits from a low operating expense structure because it's self-managed. In this regard, it has the second-lowest operating expense-to-assets ratio at 1.8%, sitting just above that of MAIN's 1.3%. This also compares favorably to that of HTGC's 2.2% and TRIN's 3.3%. Having lower expenses means that CSWC can return more capital to shareholders. Since the launch of CSWC's credit strategy in 2015, it's raised its quarterly regular dividend 29 times through both low and high-interest rate environments with no cuts, and it's also declared 25 special dividends totaling $4.01 per share over this time frame. CSWC adopts a conservative investment strategy, closing deals with loan-to-value ratios in the 40-50% range this year, ensuring a significant equity cushion to cover its debt investments. Moreover, the vast majority (98%) of CSWC's debt portfolio is in first lien debt, which stands first in line to recover principal in the event of a borrower default. As shown below, this ratio has only trended up every year since 2016 from 43% to 98%. Investor Presentation CSWC is also well-diversified, with an average investment hold size of 1.0% across a portfolio with a $1.5 billion fair value. It's also generating a solid weighted average yield of 13.5% on income-producing investments and saw portfolio growth during Q2 2024, with $108 million in new commitments across three new portfolio companies and 11 existing ones, partially offset by $77 million in debt repayments. While NAV per share did decline by $0.17 per share on a sequential basis to $16.60, that was due to net unrealized depreciation on investments and an annual RSU issuance for employees. Meanwhile, investments on non-accruals remain in check at 1.9% of portfolio fair value. What sets CSWC apart from most other BDCs is its low leverage with a debt-to-equity ratio of 0.75x, down by 7 bps sequentially, and below management's target range of 0.8 to 0.95x. This sits well below the 2.0x statutory limit for BDCs and below the 1.0 to 1.35x range for most BDCs. This gives CSWC plenty of balance sheet flexibility in either a rising rate or declining rate environment. Plus, with shares trading at a healthy premium to NAV per share, the equity market is another viable avenue for raising capital should interest rates remain stickily high. Importantly for income investors, CSWC currently supports a regular dividend yield of 9.4% with an NII-to-Dividend coverage ratio of 122%, and the cumulative dividend coverage ratio (including special dividends) is at 111%. Management targets at least maintaining the regular dividend yield in any interest rate scenario, as noted during the recent conference call: We have consistently maintained that setting a regular dividend at a level that we believe will never be cut in any foreseeable interest rate environment is key to generating stable, attractive shareholder returns over the long term. We continued our strong track record of regular dividend coverage with 122% coverage for the 12 months ended June 30, 2024, and 111% cumulative coverage since the launch of our credit strategy in January 2015. While CSWC isn't cheap by traditional BDC standards at the current price of $24.72 with a Price-to-Book ratio of 1.49x, I believe well-run self-managed BDCs should be valued based on their earnings power. CSWC doesn't appear to be pricey from this standpoint, with a forward PE of 9.6x. With a 10.4% cumulative dividend yield, a strong balance sheet, and the potential for accretive equity issuances, CSWC could deliver market-beating returns with high income. #2: Alexandria Real Estate Alexandria Real Estate Equities, Inc. (ARE) is a high quality REIT with a focus on owning life science properties in what it bills as innovation clusters. This includes high barrier to entry markets in New York City, Greater Boston, San Diego, SF Bay Area, Seattle, RTP of North Carolina, and Maryland. ARE had high exposure to quality tenants, with 92% of the top 20 tenants being investment grade rated or large-cap tenants. Its locations form a virtuous cycle, as they ensure that tenants have access to a ready pool of highly educated talent, thereby solidifying the stickiness of its tenant relationships. This is reflected by strong occupancy over the past 17 years, with occupancy never falling below 93.8%, and by the fact that 79% of leasing activity over the trailing 12 months came from its existing base of 800 tenants. ARE is seeing strong operating fundamentals, with NOI growing by 9.4% YoY during Q2 2024. FFO/share also grew by a respectable 5.4% YOY to $2.36. This was driven by robust leasing activity due to high demand, with rental rates on new and renewal leases growing by 26% and 15% on a GAAP and cash basis, respectively. Management is guiding for 5.6% FFO per share growth for the full year to $9.47 at the midpoint of the range. Longer term, ARE seeks to create value through its 'mega campus' strategy, in which it expects to grow from 74% at present to 90% of rental revenues coming from mega campuses over the next few years, furthering the in-demand nature of its properties. This is expected to be funded by dispositions of non-core assets and by a strong balance sheet. This includes having a low net debt + preferred stock-to-adjusted EBITDA ratio of 5.1x and a strong fixed charge coverage ratio of 4.5x. Most (97%) of ARE's debt is held at fixed rates, and it has a long weighted average remaining debt term of 13 years. Having a strong balance sheet positions ARE well for a 'whichever' interest rate scenario, as rising rates due to inflation means it would be able to raise rents in response, while low debt should make interest expense manageable. Lower rates would be beneficial for debt re-financings, while ARE should continue to see strong demand from tenants as it pursues a mega-campus strategy. Importantly for income investors, ARE sports a respectable 4.3% dividend yield. The dividend is well-covered by a 55% payout ratio and comes with 13 years of consecutive growth. I find ARE to be attractive at the current price of $121 with a forward P/FFO of 12.8, sitting far below its historical P/FFO of 17.9, as shown below. FAST Graphs With a well-covered 4.3% dividend yield, a strong balance sheet, and my expectations for long-term annual mid to high-single digit FFO per share growth as a conservative base case, ARE could deliver market-beating returns even without a return to its mean valuation. Investor Takeaway Both Capital Southwest and Alexandria Real Estate are well-positioned to navigate uncertain interest rate environments effectively due to their robust business models and financial flexibility. CSWC, an internally managed BDC, benefits from a low operating expense structure, conservative investment strategy, and strong balance sheet, enabling it to deliver consistent dividends in various interest rate scenarios.  Similarly, ARE, a REIT specializing in life science properties, boasts a high-quality tenant base, strong occupancy, and a well-covered dividend yield, supported by a strategic focus on mega campuses and a solid balance sheet. Both companies offer investors above-average income streams and the potential for long-term growth, making them attractive picks in a volatile economic landscape.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"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":"4.26.4","shortVersion":"4.26.4","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/2462118315"}