Ares Capital Corp. (ARCC:NASDAQ, 18.85) is in a strong position to sustain its returns, currently earning over 11% on investments. The company is one of highest quality BDCs, with the added benefit of scale. It has strong dividend coverage, and room to increase leverage towards it target level of 0.9 to 1.25x. We expect the increase to be slow without any diminution of lending standards.
Is it overvalued here?
The stock has recovered from its ACAS-purchase slump. Indeed, it is trading at a post credit crisis high. Although Ares is now trading at a premium to the BDC sector, other high-quality BDCs are trading at higher valuations. It is worth paying up for such high quality. Insiders agree, and there has been widespread insider buying in recent months.
The fee waiver that Ares introduced following the ACAS acquisition will come to end after one more quarter, but given that NOI is comfortably above the dividend, this will occur without any bumps in dividend coverage. Trading just over book, and yielding 8.5%—both at the high end of recent valuation metrics—we are holding, but comfortably so. A better-than 8% yield, well covered, from a high-quality company and with room to grow, is well worth holding. We would buy more on a pullback.
Gains boosting shareholder returns
Gladstone Investment Corp. (GAIN:NASDAQ, 11.67) continues to report solid operating results, with another increase in net investment income, which continues to exceed its regular dividend. There is also 11 cents a share accrued, so the dividend looks very secure. However, exits continue to be greater than new investments, and there was a small slip in Net Asset Value. With the recent decision to keep back some income, liquidity is strong.
Gladstone is trading just under book. On its monthly dividend, the yield is under 7%, but Gladstone—unlike most BDCs—has about 30% of its investments in equity, and it pays a semi-annual distribution from net capital gains. The amount varies of course, but including those additional distributions, the yield is well over 8%. Valuations are at the low end of the five-year range, as with Ares, but with a second dividend and room to grow, we are holding GAIN and would buy again on a pullback.
Main businesses continue to grow, while share count shrinks
Loews Corp. (L:NYSE, 48.07) saw mostly positive operating results from its holdings, particularly its largest, CNA Insurance, whose new business lines are developing well; CNA accounts for about 70% of the value of each Loews' share. Offsetting that was a modest decline in earnings at Loews Hotels and ongoing and growing losses at Diamond Offshore. Despite a long-lasting, very weak market, Diamond continues to enhance its fleet while maintaining a good balance sheet. Since its earnings are consolidated into the parent, it adds to quarterly fluctuation, but it represents only about $2 per share of value.
With about $3.5 billion in cash and investments at the holding company level—80% of it in cash—Loews has a rock-solid balance sheet with which it continues to buy back its own shares, adding another 3 million shares this past quarter. This is a long-term trend for the company; shares outstanding stood at 332 million at the end of 2017 and now stand at 303 million. Indeed, a decade ago, Loews had 40% more shares out than it does today. Notwithstanding its healthy balance sheet, Loews says it is unlikely to add another major business to its portfolio, believing businesses are very expensive in the current easy money environment.
Buying at a discount
Given its low 0.5% dividend yield, Loews is usually valued on a sum-of-the-parts basis. Today, its book value is $64.49 per share, most of which is in publicly listed, and therefore easy to value, companies. This 25% discount is compelling, close to the 10-year highs in the range, though there have been spikes a couple of times.
Though we have no argument at all with the high cash levels and patient buying discipline, we would prefer greater diversification in his assets—clearly the fortunes of CNA have an overwhelming effect on those of Loews—and we would favor a higher dividend, though that is unlikely. A recovery in the oil market, and specifically the offshore exploration business, would boost the company's reported earnings. We are holding, but would accumulate near the current price level.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."[NLINSERT]
1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Gladstone Investment and Ares Capital. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Gladstone Investment, Ares Capital and Loews. I determined which companies would be included in this article based on my research and understanding of the sector.
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