Not all dividends are cut from the same cloth. If you’re going to buy a high dividend-yielding stock, top of the list of questions to ask is how sustainable is the dividend? Is it safe? Or will it be slashed?
Ares Capital is currently offering a mouth-watering 10.87% dividend yield. That’s usually a level that would make us worry something is awry, but a deeper investigation reveals perhaps this is a hidden gem for income-seekers.
Under the Radar Firm: But What Does It Do?
Ares Capital is one of those under under-the-radar firms that doesn’t attract the glitz and pomp of a tech titan like Apple or Tesla. But the money is often made where most people aren’t looking. If you can discover a gem before the rest of the market, when capital finally flows to it, you can ride the wave. Is that the situation with Ares Capital?
First off, let’s find out what the company does.
Ares is a specialist in mezzanine debt, restructuring, rescue financing and leveraged buyouts. It has a focus on consumer products and healthcare services as well as IT.
Usually, the fund invests anywhere between $20m and $200m in companies that have EBITDAs of $10m – $250m.
Debt investments are made up to $100m and start as small as $10m.
And investments as a whole can be made via warrants, first lien loans, mezzanine debt, junior capital or even subordinated debt.
The Bull Case For Ares Capital
The first thing to like about Ares is its valuation. According to 15 analysts, the consensus fair value is $20.43 per share, which is about 10% higher than where the share price currently sits. If you’re buying a 10% dividend yield, income is usually the primary focus. Some share price appreciation is a bonus so it’s no surprise the upside is modest.
What we found really interesting about Ares is its history of revenue growth. For the last 10 quarters straight, Ares has grown year-over-year revenues up to $618 million in the most recent quarter. Not only that but operating income has been growing in tandem. In the past quarter, EBIT was reported at $459 million. That’s a pretty good number off of a relatively modest revenue figure. It suggests the company has exceptionally good control of costs.
A structural tailwind in favor of Ares was revealed recently when CEO Kipp DeVeer revealed that 95% of new leveraged buyout financing came from private capital lenders. It’s starting to look like the winds for fortune are favoring Ares, even if headwinds are hurting the economy as a whole.
We also discovered as part of our research that in its 20-year track record as a public company, it has a strong track record of delivering to shareholders. And while it’s true that the company has “just” $359 million in cash and $11.2 billion in debt, which ordinarily would be a cause for concern, the business of Ares is largely debt financing, so it’s much less of a concern than it would be for an operating business delivering a product or service.
All in all, Ares Capital ticks a lot of boxes. A shift in capital supply due to economy conditions favors the firm. It has a long track record of success and delivering an attractive yield to shareholders. And its management team has navigated financial crises before giving them ample experience to navigate choppy waters ahead.
A $5,000 investment in Ares would produce about $500 in annual income, not too bad all things considered.