Garrison Capital Inc: This 12.7% Yield Is Worth a Look
GARS Stock: Predictable Revenue
To most people, Garrison Capital Inc (NASDAQ:GARS) won’t sound like a familiar name. But if you are a yield-seeking investor, then this New York City-based specialty finance company deserves your attention.
Garrison Capital is in the lending business. But rather than being a bank, it focuses on serving a particular type of borrowers: U.S. middle-market businesses.
Middle-market businesses usually have annual earnings before interest, taxes, depreciation, and amortization (EBITDA) of between $5.0 million and $30.0 million. While these numbers look solid, the companies are simply not as established as their large-market counterparts.
The result is that middle-market firms cannot always get loans from traditional banks. The tightening of banking regulations over the last decade has only made it more difficult for these businesses to obtain financing.
And that’s where Garrison Capital Inc found its opportunity. By providing financing solutions to middle-market businesses, the company can collect oversized interest payments.
Furthermore, while Garrison Capital makes both debt and equity investments, the bulk of its portfolio is made up of secured loans. That allows it to generate a predictable stream of cash flow, which can then be used to set up a dividend policy.
As a matter of fact, the company has to pay generous dividends. Structured as a business development company (BDC), Garrison Capital is required by law to distribute at least 90% of profits to shareholders through dividends every year. This pass-through structure allows the company to avoid paying taxes at the corporate level.
Right now, Garrison Capital has a quarterly dividend rate of $0.28 per share, which comes out to an annual yield of 12.7%.
Garrison Capital: A Middle-Market Lender
Obviously, with a yield in the double-digits, GARS stock does not look like the safest bet. However, if you take a closer look, you would see that the company actually has a solid business model in place.
As I mentioned earlier, the focus on middle-market borrowers allows Garrison Capital to earn outsized returns on its investments. In the second quarter of 2018, the company collected total repayments of $73.8 million at a weighted average yield of 11.3%. (Source: “Earnings Presentation,” Garrison Capital Inc, last accessed August 29, 2018.)
More importantly, Garrison Capital has put in a lot of effort managing the risk associated with its high-yield debt investments. For instance, 97.9% of the company’s portfolio consisted of first-lien senior secured loans as of June 30, 2018. When Garrison Capital is a first-lien lender, it will be the first one in line to get paid in the event of a borrower liquidation.
At the same time, the company’s portfolio is also well-diversified. Right now, Garrison Capital has investments in 71 companies coming from more than 20 different industries. Its largest industry exposure, Internet software and services, accounts for just 16% of its total portfolio. So if one of these companies or industries encounters a downturn, it likely won’t cause too much damage to its entire portfolio’s financials.
Meanwhile, Garrison Capital has been adding floating rate loans to better position itself for the rising interest rate environment. By the end of the second quarter of 2018, 99.5% of its portfolio was made up of floating-rate investments. Management estimated that for every 25 basis point increase in the benchmark interest rates, the company would earn an additional $0.01 per share of annual net investment income.
GARS Stock: Covering the Payout
Of course, like most ultra-high yielders, GARS stock is not perfect. In particular, the company’s dividend coverage wasn’t always stellar. Last year, Garrison Capital earned $17.2 million, or $1.07 per share of net investment income while declaring and paying total dividends of $1.12 per share. Therefore, the company’s profits were not enough to cover its dividends. (Source: “Garrison Capital Inc. Declares First Quarter 2018 Distribution of $0.28 Per Share and Announces Fourth Quarter and Fiscal Year Ended December 31, 2017 Financial Results and Earnings Call,” Garrison Capital Inc, March 6, 2018.)
This year, though, things have improved quite a bit. In the first six months of 2018, Garrison Capital generated net investment income of $0.58 per share. Given its total dividends of $0.56 per share declared during this period, the company achieved a distribution coverage ratio of 1.04 times for the first half of this year. (Source: “Garrison Capital Inc. Declares Third Quarter 2018 Distribution of $0.28 Per Share and Announces Second Quarter 2018 Financial Results and Earnings Call,” Garrison Capital Inc, August 7, 2018.)
As a conservative income investor, I would like to see a stronger dividend coverage as it would leave a wider margin of safety. But in the world of double-digit yielders, being able to make more than enough money to cover one’s dividend payout is already an impressive feat.
Besides, interest rates are on the rise. If Garrison Capital Inc can make more money under increasing interest rates as its management anticipated, its 12.8% yield would certainly be worth considering.
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