Ares Capital Corporation: For Those Who Think an 8.7% Yield is Not High Enough
Looking to Collect Big Yield? Read This
Let’s be honest here: would you be happy to earn an annual dividend yield of 8.7%?
I certainly would. Given that the average S&P 500 company pays under two percent at the moment, anything that’s yielding higher than eight percent essentially allows you to earn more than four times that of the benchmark’s average. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed August 6, 2019.)
Ares Capital Corporation (NASDAQ:ARCC) happens to be an eight-percent-plus yielder. Paying quarterly cash dividends of $0.40 per share, ARCC stock offers an annual yield of 8.7%.
The best part is, if an investor buys Ares Capital stock today, chances are they’ll collect an even higher cash payout than what the current yield suggests.
ARCC Stock: Returning Cash to Shareholders
Headquartered in New York City, Ares Capital Corporation is a specialty finance company that serves middle-market businesses in the U.S.
As I said, Ares Capital is a generous dividend payer. And the company can afford to pay oversized dividends because of its lucrative business.
You see, because of the tighter banking regulations that has been put in place over the years, traditional banks don’t always lend to middle-market companies. Therefore, if these companies want to get financing, they often have to pay higher interest rates. And that’s where Ares Capital Corporation found its opportunity.
By lending to this underserved group of middle-market businesses, the company earns an oversized interest income stream. As of June 30, 2018, the weighted average yield of debt and other income-producing securities in Ares Capital’s portfolio at fair value was 10.5%. (Source: “Ares Capital Corporation Announces June 30, 2019 Financial Results and Declares Third Quarter 2019 Dividend of $0.40 Per Share,” Ares Capital Corporation, July 30, 2019.)
And because Ares Capital chooses to be regulated as a business development company (BDC), it must return at least 90% of its profits to shareholders through regular dividend payments. Combining a lucrative business with the BDC structure, ARCC stock has become one of the highest yielders on the market.
Of course, in this day and age, high yield debt don’t really sound like the safest bet. The good news is, Ares Capital takes risk management very seriously.
For instance, the company’s portfolio is well-diversified. At the end of June 2019, Ares Capital had investments in 345 companies, meaning its average position accounts for just 0.3% of its portfolio. Also, ARCC’s largest position represents just three percent of the company’s portfolio fair value. (Source: “Investor Presentation August 2019,” Ares Capital Corporation, last accessed August 6, 2019.)
Moreover, these companies come from more than a dozen different industries. Ares Capital’s three largest industry exposures are healthcare services (20%), business services (19%), and consumer products (seven percent). What this means is that if one company or industry enters a downturn, the impact on Ares Capital’s company-level financials will likely be limited.
At the same time, ARCC has been focusing on senior secured lending. At the end of the second quarter of 2019, 41% of the company’s portfolio was invested in first-lien senior secured loans. The company also had another 33% of its portfolio invested in second-lien senior secured loans. Adding in ARCC’s seven percent investment in Senior Direct Lending Program LLC and you’ll see that senior secured loans accounted for 81% of the company’s total portfolio.
Ares Capital’s solid investment portfolio has allowed it to achieve sufficient coverage for its outsized distributions. In 2018, the company generated core earnings of 1.68 per share while declaring and paying total cash dividends of $1.54 per share, meaning it outearned its dividends for the year. (Source: “Ares Capital Corporation Announces December 31, 2018 Financial Results, Declares an Increased First Quarter 2019 Dividend of $0.40 Per Share and Additional Dividends Totaling $0.08 Per Share for 2019,” Ares Capital Corporation, February 12, 2019.)
Ares Capital Corporation: Earn a Yield Higher Than 8.7%?
Now, back to the beginning of this article, when I said investors can look forward to collecting cash payouts that are higher than its current 8.7% yield. How would that be possible?
Well, that’s because during Ares Capital Corporation’s fourth quarter 2018 earnings report, management made it clear that they would pay investors, “additional dividends totaling $0.08 per share for 2019.” These dividends will be distributed in four payments of $0.02 per share for each quarter of the year. (Source: Ibid.)
Mind you, what management was talking about was not the company’s regular dividends. Instead, they were talking about their plan of paying four special dividends, totaling $0.08 per share.
More than halfway through the year and we see that Ares Capital Corporation has followed through on that plan. On March 29, each investors of ARCC stock received a regular quarterly cash dividend of $0.40 per share and a special dividend of $0.02 per share. And then on June 28, the exact same thing happened.
The company has plenty of resources to continue with the cash return. According to the most recent earnings report, Ares Capital Corporation generated core earnings of $0.49 per share. The amount easily covered its total cash dividends of $0.42 per share declared for the period ($0.42 per share includes the regular dividend of $0.40 per share, plus an additional dividend of $0.02 per share).
“We announced this morning that we declared a regular third quarter dividend of $0.40 per share. Also during the third quarter, we will pay the previously declared additional dividend of $0.02 per share,” said Penni Roll, Ares Capital’s Chief Financial Officer. “The third quarter regular dividend as well as the $0.02 per share additional dividend are both payable on September 30, 2019 to stockholders of record on September 16.” (Source: “Ares Capital (ARCC) CEO Kipp DeVeer on Q2 2019 Results – Earnings Call Transcript,” Seeking Alpha, July 30, 2019.)
At the end of the day, keep in mind that the official yield of ARCC Stock—the number you see on Yahoo! Finance or MarketWatch—only includes regular quarterly dividends in the calculation. Because of the company’s additional dividends of $0.02 per share to be paid in both the third and fourth quarters of 2019, investors who purchase ARCC stock today can look forward to collecting bigger payouts than its official yield of 8.7%.