Ares Capital: 9% Yielding Industry Leader Looks Undervalued

Ares Capital: 9% Yielding Industry Leader Looks Undervalued

Summary

ARCC yields 8.78%, with 1.27X coverage in Q4 ’21.

It’s a BDC industry leader, with a long record of good shareholder returns.

It looks undervalued vs. the BDC industry.

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8vFanI/iStock via Getty Images If you’re looking to invest in an industry leader in the Business Development Company industry, known as BDC’s, you may want to check out Ares Capital Corp. ( ARCC ).

Like most of the BDC’s we’ve covered in our articles , ARCC has a well-covered high dividend yield.

ARCC is one of the largest BDC’s – it’s a U.S. direct lender with a $20B portfolio, and a long track record – it has invested $77B since its 2004 IPO. Profile:

ARCC specializes in acquisition, recapitalization, mezzanine debt, restructurings, rescue financing, and leveraged buyout transactions of middle market companies. It also makes growth capital and general refinancing. It prefers to make investments in companies engaged in the basic and growth manufacturing, business services, consumer products, health care products and services, and information technology service sectors.

ARCC is externally managed by Ares Management, which has over $200B in global assets under management, and is active in the credit, private equity, real estate, and strategic initiatives industries. ARCC site A major change in the Capital markets which has benefited ARCC and other BDC’s over the past several years has been the exiting of traditional banks from direct lending to middle market companies. ARCC site ARCC has seen its reviewed investments surge by 4X since 2015. Management has stringent investment guidelines – ARCC only takes on ~5% of the investments that it reviews. ARCC site This has led to a very low loss rate of under 10 basis points in its 1st Lien category, and less than 20 basis points in its 2nd Lien & Subordinated program. As of 12/31/21, loans on non-accrual status represented 0.8% of total investments at amortized cost (or 0.5% at fair value). ARCC site Holdings:

75% of ARCC’s loans are Senior Loans, with 1st Liens at 47%, 2nd Liens at 23%, and 5% in its Senior Direct Lending segment. It also has 4% in Senior Subordinated Loans, 8% in Preferred Equity, and 13% in Equity. ARCC site Software & Services remained its top industry exposure, increasing to 22% in Q4 ’21, vs. 19% in Q3 ’21; followed by Healthcare, at 11%, and Commercial & Professional Services, at 9%. Those 3 industries comprised 42% of ARCC’s portfolio, as of 12/31/21.Management has minimized ARCC’s exposure to certain sub-sectors, having less than 1% exposure than the high yield and leveraged loan industries to Hotel & Gaming, and Transportation; and under 2% exposure to Oil & Gas, and Media & Entertainment. ARCC site ARCC’s largest exposure was 1.3%, vs. a BDC peer average of 4.8%, as of 12/31/21, while its top 10 positions comprised ~11% of its portfolio, vs. its peer average of 25.7%. ARCC site Earnings:

Q4 ’21 had strong top line growth, with total Investment Income rising 20%. NII was up 5.68%, while Core EPS rose 7.4%. Realized Gains, which are traditionally lumpy on a quarterly basis, swung from a -$183M loss to a $16M gain in the quarter, while Unrealized Gains dropped to $124M, vs. $332M in Q4 ’20. The total share count grew 9.46%, which led to a 3.7% drop in NII/Share in the quarter.

Full year 2021 Total Investment Income rose 20%, while NII fell -6.7%. However, Core EPS rose 16% during 2021. NII/Share fell 11.23%, while NAV/Share rose by 11.73%.

The share count rose ~5% in 2021, and in January 2022, ARCC did another public offering of 10,000,000 shares of its common stock, which represents ~2%. Hidden Dividend Stocks Plus New Commitments & Exits:

ARCC made new investment commitments of approximately $5.9B in Q4 ’21, of which approximately $5B were funded. 64% were in first lien senior secured loans, 17% were in second lien senior secured loans, 2% were in the subordinated certificates, 2% were in senior subordinated loans, 4% were in preferred equity and 11% were in other equity. 83% of these commitments were in floating rate debt securities, of which 95% contained interest rate floors.

New investment commitments included 28 new portfolio companies, 55 existing portfolio companies, and 3 additional portfolio companies through the Senior Direct Lending Program, a JV with Varagon Capital Partners and its clients, to fund first lien senior secured loans.

As of 12/31/21, 192 separate private equity sponsors were […]

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