Saratoga: Well Diversified BDC But Has An Overstretched Payout Ratio

Summary

SAR had a record year with exceptional AUM and NII growth.

The management has launched a new dividend strategy in 2015 to regularly raise the dividends but now the payout ratio is overstretched.

The company is yielding 7.34%, making it an attractive target for income investors.

metamorworks/iStock via Getty Images Investment thesis

Saratoga Investment Corp ( SAR ) is a stable BDC company with a good management team in place. They were the few ones who could produce exceptional shareholder returns in the last 12 months. But the question remains if they will be able to maintain their current growth and dividend policy. The stock is fairly valued and priced exactly at its NAV while the 7+% dividend is attractive for income investors. The management launched a dividend strategy in 2015 and since then they raised the dividend by more than 200%. Business Model

Saratoga Investment Corp. is a business development company specializing in leveraged and management buyouts, acquisition financings, growth financings, recapitalization, debt refinancing, and transitional financing transactions at the lower end of middle-market companies. It structures its investments as debt and equity by investing through first and second lien loans, mezzanine debt, etc. The firm primarily invests $5 million to $20 million in companies through direct lending as well as participation in loan syndicates. SAR’s investment portfolio has an average 8.2% yield which qualified them into the upper fifty percent of BDCs. The majority of their portfolio is in secured loans. The company’s biggest holding is in the Healthcare Software sector with 11.1%, the IT Services sector with 10.0%, and in the Education Services sector with 9.3% as of September 30, 2021. Source: Q2 2022 Presentation Financials & Earnings

Q2 2022 results

The company’s consistent strong long-term originations contribute to growing assets under management. Q2 2022 outperformed the estimate by more than 10%. NII estimate was $0.5 per share and SAR reported $0.57NII per share. As of August 31, 2021, Saratoga Investment’s assets under management were $666.1 million, an increase of 31.1% year-on-year. AUM up was also up by 20% since year-end but it was down by 1.6% from Q1 2022. NAV per share has increased in 14 of the past 17 quarters and it was up by 1.25% compared to Q1 2022. In addition, SAR added fourteen new portfolio companies during LTM Q3 2021.

93% of SAR’s loan investments hold their highest internal rating; zero nonaccrual at quarter-end but this 93% excludes their investment in their CLO and their equity positions. Approx. 97% of the company’s investments have floating interest rates, most with floors of 1.0% or higher. Floors of new investments reset at higher levels than current rates this year. Debt is primarily at fixed rates and long-term and has an investment-grade rating of “BBB+”. Valuation

SAR has a forward Non-GAAP P/E ratio of 14.56 while the sector median is 11.19. If we compare it to SAR’s closest peers, TriplePoint Venture Growth ( TPVG ) which invests between $5 million and $50 million to companies has a P/E ratio of 13.73 while Stellus Capital Investment Corporation ( SCM ) which also invests between $5 million and $50 million to companies and has a P/E ratio of 12.31. As you can see they can invest more than SAR in each of their investment portfolio companies but it is still worth looking at them as a comparison. Based on these ratios SAR is rather fairly valued than undervalued at the moment.

When looking at the Price to NAV ratio we can see the same. In the past 12 months, the closest returns to SAR were Oxford Square Capital Corp. ( OXSQ ) and First Eagle Alternative Capital BDC, Inc. ( FCRD ). This is why I added them to our Price to NAV comparison chart. Source: Q2 2022 Presentation

OXSQ invests between $5 million and $30 million to companies and has a P/E ratio of 13.03 and FCRD invests between $10 million and $25 million to companies and has a P/E ratio of 12.98. SAR’s Price to NAV is exactly one that also supports the fairly valued stock price theory. A growth investor can find better targets in SAR’s peers based on P/E ratios and Price to NAV ratios as well. Source: Seeking Alpha Company-specific Risks

The Business Development Company sector is a competitive one. They compete for the companies they lend to and they compete to see who can offer lower interest rates. The sector will be affected by the FED interest rate hike next year. Despite the […]

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