Bear of the Day – BlackRock Capital Investment Corp.
BlackRock Capital (BKCC) is a class of investment known as a “Business Development Company” (BDC) which were created by a 1980 amendment to the Investment Company Act of 1940. BDCs are unregulated closed-end investment companies that invest in small and mid-sized businesses. They are similar to Private Equity or Venture Capital Funds, except that they are usually traded on an exchange like a stock, instead of being open only to very wealthy investors.
BlackRock Capital provides middle-market companies with flexible financing solutions, including senior and junior, unsecured and subordinated debt securities and loans and equity securities. Unlike a traditional private equity firm, BlackRock Capital makes non-control investments in middle-market companies.
The goal of a BDC is to invest in non-public companies that investors would not otherwise have access to and to provide cash distributions based on the cash flows of its investments. Taxed as a Regulated Investment Company (RIC), BlackRock Capital pays little or no corporate income tax as long as it passes through at least 90% of taxable income as dividends to investors.
Unfortunately, credit quality across the middle-market lending space has been declining lately and BDCs like BlackRock Capital have seen a smaller pool of poorer performing loans than in the past. In their most recent earnings press release, Chairman and interim CEO James Keenan commented, "In the current market conditions of compressed credit spreads, higgher leverage levels and weaker structures, we remain highly selective in new investment opportunities and focused on opportunities with strong underlying credit metrics."
Unfortunately, this remains a familiar sentiment in the middle-market lending sector. As large investment vehicles like Pensions, Public Retirement Funds and Endowments - with cumulative trillions of dollars that need to be invested - reach for yield in a low interest rate environment, loan quality is getting squeezed, with less-deserving issuers getting more attractive deals.
BlackRock Capital Shares have declined nearly 40% over the past 4 years as the company has missed quarterly estimates, even as the consensus has steadily declined. Due to declining earnings estimates, BlackRock Capital is a Zacks Rank #4 (Sell).
Investors may notice the eye-popping 11% dividend yield on Blackrock Capital shares, but as is often the case with stocks that pay double-digit dividend yields, it’s actually probably a red flag. Income stocks like Utilities and REITs can be evaluated on yield when they own a relatively stable portfolio of income producing assets. If the share price is expected to be stable, their regular yield makes them act more like a bond or portfolio of bonds.
An unusually high yield is often a signal that the markets are unsure about the performance of the underlying assets and is either discounting the chances that the company will be able to continue paying the dividend, or pricing the stock based on an expectation that the BDC will have to write down or write off non-performing assets, causing the shares to decline - and erasing the apparently high yield. These are generally stocks to avoid.
Investors looking for income producing pass-through type stocks should consider Omega Healthcare Investors (OHI) or Ready Capital Corp (RC) – both of which are specialized REITS which yield over 5% annually and carry a Zacks Rank #1 (Strong Buy).
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