Ares Capital: A Magnificent 9% Yielding Cash Cow

seekingalpha11-20 18:18

Ares Capital improved its high balance sheet quality in Q3 and supports its dividend with NII, making it a reliable high-yield investment.The BDC's portfolio grew with $3.9B in gross commitments, ...

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Ares Capital, however, benefited from a surge in originations in the September quarter and supported its dividend with net investment income. Ares Capital's portfolio also grew in Q3'24 and the BDC improved its dividend coverage profile slightly. At the same time, Ares Capital did not see a major change in its balance sheet quality, an indication of a well-run BDC. Ares Capital is currently, at a price of $21.83, valued at a price-to-NAV ratio of 1.1X. While not cheap, the BDC is one of the best investments dividend investors can make in the industry, in my opinion. Data by YCharts Previous rating I rated Ares Capital a buy in my last work on the BDC in August—A Top BDC For Turbulent Times—as shares traded at a small premium to NAV at the time. Ares Capital, after Q3 earnings, remains a solid yield play that offers a dependable and well-supported 9% yield for investors that focus on high-quality dividend income. The non-accrual percentage also declined Q/Q in Q3'24 and Ares Capital has a top-notch record in limiting loan losses over time. In my opinion, Ares Capital is a top shelf BDC with attractive long-term income potential. Ares Capital: low non-accrual percentage, portfolio growth, strong coverage profile Ares Capital runs a senior secured loan strategy that consists chiefly of first liens. In the September quarter, the BDC had 53% of its assets invested in first liens and 11% in second liens. Ares Capital generates recurring interest income from its term loans that is used to fund a generous $0.48 per-share dividend for shareholders. The main supporting drivers of Ares Capital's quarterly dividend are the BDC's portfolio growth and impressive asset quality. Ares Capital Ares Capital continued to run a first lien strategy in the September quarter, and the portfolio overall performed according to my expectations. The non-accrual percentage based off of fair value was 0.6%, showing a slight 0.1 PP change compared to the previous two quarters, indicating a high level of balance sheet quality.   Portfolio, Non-Accrual Trend Q3'23 Q4'23 Q1'24 Q2'24 Q3'24   Portfolio Value, fair value $21,929 $22,874 $23,124 $24,973 $25,918   Non-Accrual Amount (cost, $M) $266 $295 $397 $360 $323   In Percent 1.2% 1.3% 1.7% 1.5% 1.3%   Non-Accrual Amount (fair value, $M) $136 $136 $168 $177 $166   In Percent 0.6% 0.6% 0.7% 0.7% 0.6%   Click to enlarge (Source: Author) The BDC has had great success with its strict underwriting strategy throughout its life as a publicly listed BDC. Ares Capital has historically had very limited loan losses, approaching 0.0%, which attests to the BDC's success focusing chiefly on first liens. Ares Capital Another favorable development in the company's business is the trend in new originations. Ares Capital originated $3.9B in gross commitments in the third-quarter, showing 145% growth year-over-year. They also exceeded the previous month's record of $3.86B, showing that Ares Capital has plenty of opportunities right now to deploy capital. A strong trend in commitments (new originations of term loans) could be a way for Ares Capital to offset declines in interest income that may be related to the Federal Reserve's attempts to lower the federal fund rate. Further, if the U.S. economy keeps growing as it is right now, the Federal Reserve may lower federal fund rates only very slowly in the quarters ahead, which could potentially even allow the BDC to grow its net investment income.   in $M Q3'23 Q4'23 Q1'24 Q2'24 Q3'24   Gross Commitments $1,598 $2,384 $3,554 $3,857 $3,919   Exits of Commitments ($1,280) ($1,427) ($3,414) ($1,376) ($2,598)   Net Commitments $318 $957 $140 $2,481 $1,321   Click to enlarge (Source: Author) Ares Capital supported its dividend reliably with net investment income in Q3: the BDC generated a total of $361M in net investment income, showing 25% growth. Per-share, Ares Capital generated $0.57 in net investment income, which calculates to a dividend coverage ratio of 1.19X. In Q2'24 and in the last trailing-twelve months period, the BDC had dividend coverage ratios of 1.21X and 1.20X. The coverage ratios over all period reflect high safety margins, which is why I believe that Ares Capital should be able to continue to pay its 10% yield going forward. Ares Capital Ares Capital's valuation Ares Capital's shares have risen 8% year-to-date, and they are currently trading at a P/NAV ratio of 1.10X. This, however, is slightly above the longer term, 3-year price-to-NAV ratio of 1.06X. Blackstone Secured Lending (BXSL), which I rate a strong buy due to its impressive balance sheet quality and dividend coverage profile, is trading at an even higher NAV multiplier of 1.18X. I like Blackstone Secured Lending a lot and would group it in terms of balance sheet quality, dividend coverage and consistency of results, right at the top of the BDC market, next to Blackstone Secured Lending and Hercules Capital (HTGC). Given the quality and dependability of Ares Capital's net investment income and well-supported dividend, the BDC could trade, in my opinion, at a higher premium to its reported NAV, in my opinion. I see a 1.10-1.15X price-to-NAV ratio as realistic and easily achievable for Ares Capital... which calculates to a fair value range of $21.75 to $22.75 per-share, implying up to 5% upside potential. The calculation above is based off of Ares Capital, having a net asset value of $19.77 per-share as of the end of the September quarter. Data by YCharts Risks with Ares Capital The Federal is cutting the federal fund rate and so far, this year has changed interest rates by 75 basis points. More rate cuts are almost guaranteed to follow, which could pressure BDCs with large variable rate loans in their portfolios. Ares Capital had 69% of its assets invested in variable rate loans, so the BDC will most likely see headwinds in terms of NII growth going forward. What would change my mind about Ares Capital is if the BDC failed to support its dividend with NII or if we saw an increase in the non-accrual percentage. Final thoughts  Ares Capital is a top BDC choice for me when it comes to the generation of durable and high-quality dividend income. Ares Capital supported its dividend with net investment income in Q3, the balance sheet quality—as measured by the non-accrual percentage—improved Q/Q and the BDC is seeing some solid momentum in terms of commitments. Although shares are not cheap, the peace of mind that comes with an ARCC investment is worth the premium, in my opinion. Ares Capital proved once again that it is one of the best BDCs in the market with strong dividend coverage and a high safety margin, and it remains a top choice for BDC investors.","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":"analysis","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":"4.29.2","shortVersion":"4.29.2","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/2484907193"}