Ares and Other Closed-End Funds See Reversal in Valuations
How Ares Capital Is Building Its Portfolio for 2016
Higher dividend
As of April 2016, Ares Capital’s (ARCC) stock had fallen by ~12% over the past year. The company is building up a portfolio of new partnerships and programs, resulting in a decline in average yields. The company paid a dividend of $0.38 per share, which was on par with the dividend paid the year before.
With a dividend yield of ~10% and improving portfolio yields, the company may provide better returns to its shareholders over the next few quarters. Here is how some of Ares Capital’s peers compare in terms of dividends:
Prospect Capital (PSEC): 13%
BlackRock Capital Investment (BKCC): 9.8%
Blackstone (BX): 7.2%
KKR & Co. (KKR): 8%
Together, these companies form 6.3% of the PowerShares Global Listed Private Equity Portfolio ETF (PSP).
Ares Capital’s stable net asset value, higher investment income, and deployment of capital through new partnerships has provided good support for its stock price.
Fair valuations
Currently, Ares Capital is trading at 9.5x on a one-year forward earnings basis. Its peers are trading at 8.2x. Historically, the company has traded at a premium to its peers due to its quality portfolio and strategic partnership with GE Capital. The market tends to give a higher premium to investment management companies investing in debt when they have moderately leveraged balance sheets. However, as Ares has increased its leverage, the premium has declined marginally in 2016.
Investment management firms have experienced some yield compression over the past two years stemming from the low interest rate environment. Ares Capital’s yields have declined in the current quarter due to building up of its SDLP (senior development lending program) portfolio.
JV with Varagon
If Ares Capital can improve originations in the upcoming quarter with a similar or better yield profile, then shareholders may see higher investment and distributable income. The company’s recent joint venture with Varagon Capital Partners and AIG (AIG) could also provide Ares Capital with a strong platform for new originations.
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