The Market’s Ignorance Of Ares Capital Corporation (NASDAQ:ARCC)

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Ares Capital Corporation’s (NASDAQ:ARCC) poor performance of late rates, in our view, strongly. We believe it isn’t commensurate with a level of risk primarily due to its 2nd lien exposure. Yet, the market seems to ignore the company’s past several quarters of strong to very strong results. Is this now an unusual buying opportunity?

The Largest BDC

Ares Capital is the largest business development company (BDC). A BDC borrows funds at low rates loaning to businesses at higher rates. The company’s interest rates for borrowed funds generally range between 2-3%. The average loan rate equals 8%. BDCs also maintain a leverage ratio which for Ares at the end of the year equaled 1.2, within the company’s target. Management noted in its prepared remarks at the last quarterly conference a leverage drop to 1.15.

The next slide summarizes the company’s assets.

Summary of Ares Investments

Ares

In the case of Ares, it holds approximately 25% of its assets in a 2nd lien position. This strategy, in our view, adds a level of measured risk. The balance of the investments are 1st lien. Its investments consist of fewer than 10% in cyclical types of businesses. Non-accruals were less than 1% at the end of 2022. Overall, this is a conservatively operated BDC.

Results

To better understand Ares strong performance, we begin with business results from the past several quarters, primarily viewing Net Asset Value per share (NAVI) and Net Investment Income per share (NAVII) results.

Ares 4th 21 3rd 21 2nd 21 1st 21 4th 20 3rd 20 2nd 20 1st 20
NAVI* $19.00 $18.50 $18.00 $17.50 $17.00 $16.50 $15.75 $15.50
Core $0.58 $0.47 $0.53 $0.43 $0.54 $0.39 $0.39 $0.41
NAVII $0.52 $0.40 $0.39 $0.33 $0.54 $0.39 $0.39 $0.54
Divy ** $0.45 $0.41 $0.41 $0.40 $0.40 $0.40 $0.40 $0.40

* Rounded.

** Ares announced at least a $0.45 dividend for the rest of the year.

The company’s NAVI moved from $15 to $19 per share in the past 8 quarters steadily climbing. Both core earnings and NAVII bottomed through early 2021 while growing toward $0.60, trailing a few quarters behind NAVI. The dividend increase lagged by several quarters increasing from $0.40 to $0.45 only in recent quarters. The NAVII number seems also to lagging, and if so, future dividend increases are coming.

Market’s Ignorance

We have included self-generated charts using TradeStation Securities software.

ARCC Weekly

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The first chart, above, shows the weekly bars for Ares. A key marker white line indicates a strong support line near $19, which calculates out to a 9.5% yield. Also, the stochastic at the bottom approaches underbought.

The next chart, the day bar chart for the DOW Jones Industrials (DJI), indicates a price trading close to, but under, the white (200 SMA) line, while being overbought. This could mean that a further downside move is coming.

DOW Day

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The 3rd chart, Ares’ day bar, shows a lot of similarities to the Dow Jones chart above. The price has been trading below the white line, 200 SMA. This trading downward comes in-spite of improving performance of the company noted above. The stochastic for this day bar chart is becoming overbought.

ARCC Day

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A discussion of a natural cycle that generally exists with distribution-intensive companies is important for investors to better determine times for more optimal price entry points. Companies such as Ares, in the natural cycle, generally follow a pattern described next.

Prices tend to increase heading into the ex-dividend day followed by a drop in price the day of ex-dividend, followed again in a few days or weeks by an increase in price up to the pay day. The cycle ends with prices generally falling for some weeks after that pay day. Sometimes the price decreases can be dramatic. Ares’ payday is coming at the end of March. We expect the price to fall after that day. For investors, waiting to buy for a month or two might be a better strategy.

Conclusion & Risks

With Ares payday just around the corner. Due to uncertainty in world markets, lower entry prices might be predestined in the short time horizon. The company also reports earnings in April, generally later in the month. This earnings report might be telling about directions for future dividends. In our view, NAVII is the most important number to watch. A continuation of $0.50 indicates that more basic dividend increases are likely on the way.

The primary risk we sense is the continued possibility for a falling market. Ares clearly is following the market rather than its strengthening fundamentals. With the unsettled nature of world business, we suspect that markets will continue to be volatile for the unforeseeable future. Buying at prices in the high teens might be excellent opportunities for entering or adding to Ares especially with the market’s ignorance of the real value of Ares.

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