Ares Capital Stock: Load Up The Truck With 9.3% Yielding ARCC

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Ares Capital Corporation (NASDAQ:ARCC) and other high-quality business development companies are currently trading at or near their best valuations in more than a year.

Ares Capital has remained a top BDC to own since its inception due to its covered dividend, safe first lien-focused portfolio, and consistent ROE results.

Ares Capital shares are also trading at a discount to book value, making the BDC an especially appealing dividend investment.

Shifting Into High Quality BDCs

With a recession expected to hit the U.S. economy in 2022 or 2023 and growth stocks taking a beating one after another, high-quality business development firms like Ares Capital have the potential to deliver strong returns to shareholders.

Business development firms lend money to companies that are underserved by the traditional finance industry, as a result of increased risk aversion following the financial crisis of the 2000s. Ares Capital has found a profitable niche in lending money to middle-market companies, and the BDC’s investment strategy is based on a strict ‘don’t lose money’ lending policy.

Ares Capital primarily invests in Senior Secured Loans with a high likelihood of repayment by the BDC’s borrowers. In the first quarter, 71% of Ares Capital’s portfolio was invested in secured loans, the majority of which were First and Second Liens, as well as loans extended to companies through the company’s Senior Direct Lending Program. These liens are of exceptional quality and are extremely unlikely to default.

Ares Capital - Highly Diversified and Predominately Senior Secured Portfolio

Portfolio Summary (Ares Capital Corp)

Strong And Consistent Shareholder Returns

Investors are becoming concerned, and the valuations of business development companies reflect this. Even ARCC, which has strong credit quality, a diverse portfolio, and an overall good investment track record, has begun to trade at a discount to book value.

Ares Capital is one of the best BDCs in the market due to its strong ROE results over the last decade. Ares Capital’s book value has increased by 27% since its inception, while the dividend has remained well-covered.

Ares Capital has produced 45% dividend growth in addition to 27% book value growth, making ARCC a top business development company to own for dividend generation.

Ares Capital Strong Investment Performance

Strong Investment Performance (Ares Capital Corp)

Ares Capital’s success has been backed up by consistently strong investment results (strict due diligence). Since 2005, the BDC has averaged a 10% core return on equity.

Ares Capital achieved even stronger financial results during the Covid-19 pandemic, with returns on equity of 10.6% (2020) and 11.2% (2021). Ares Capital’s portfolio performance is distinguished from that of other business development firms by its length and consistency.

Ares Capital Core Return On Equity

Core Return On Equity (Ares Capital Corp)

95% LTM Pay-Out Ratio

ARCC stock yields 9.3% based on its regular quarterly dividend payment of $0.41 per share. The BDC also currently pays a quarterly supplemental dividend of $0.03 per share, but this dividend is not permanent, which is why I don’t include special dividends in yield calculations.

Ares Capital saw a strong recovery in net investment income in 2021 as the investment climate improved, and the LTM pay-out ratio was 95%.

Ares Capital Payout Ratio

Pay-Out Ratio (Author Created Table Using BDC Reports)

Finally Trading At A Discount

In June, Ares Capital’s stock corrected and began to trade at a significantly lower book value multiple. ARCC is currently trading at 0.95x book value, which is close to the stock’s lowest P/B multiple in the last year. When a high-quality BDC, such as Ares Capital, trades at or below book value, I believe the stock represents an extremely appealing value proposition.

ARCC price to book value
Data by YCharts

Why Ares Capital Could See A Lower Stock Price

A recession could result in increased loan losses for the credit industry as a whole, as well as for Ares Capital. Ares Capital has an excellent credit history with low loan losses, indicating that the company has strict credit risk management processes in place.

Recessions, on the other hand, typically result in higher loan losses, and more companies face financial difficulties, which could theoretically lead to declining asset valuations. A significant increase in credit losses would almost certainly result in ARCC trading at a lower valuation multiple.

My Conclusion

Ares Capital is a high-quality business development firm that has covered its dividend with net investment income over the long term.

ARCC is very appealing to dividend investors due to its strong and consistent ROE performance, low historical loan losses, and the discount to book value.

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