This High-Yield Stock Deserves a Look
In the bond market, the highest yielders are usually considered junk bonds. Therefore, it shouldn’t come as a surprise that, in the stock market, investors tend to have second thoughts about putting their money in companies with ultra-high dividend yields.
The thing is, though, if you decide to ignore high-yield stocks altogether, you could be missing out on some serious income opportunities.
Case in point: Garrison Capital Inc (NASDAQ:GARS) is currently one of the highest-yielding companies trading on the Nasdaq. And yet, the company actually has more than enough resources to back its payout.
Let me explain…
Garrison Capital Inc provides financing solutions to middle-market businesses in the United States. While the company makes both debt and equity investments, its main focus is on secured lending.
The neat thing is, due to the changes in the regulatory environment over the years, large banks don’t usually lend to middle-market companies anymore. As a result, these companies have to pay higher costs to get financing.
To middle-market lenders like Garrison Capital, that has created an oversized interest income stream.
In the first quarter of 2018, Garrison Capital made $36.9 million of debt investments in five new portfolio companies, at a weighted average yield of 9.5%. (Source: “Earnings Presentation First Quarter Ended March 31, 2018,” Garrison Capital Inc, last accessed May 11, 2018.)
At the same time, the company collected $35.9 million in repayments. That translated to a weighted average yield of 10.6%.
With solid returns from its debt portfolio, Garrison Capital was able to establish a generous dividend policy.
Paying quarterly dividends of $0.28 per share, GARS stock offers a staggering annual yield of 13.3%.
Managing the Risks
Of course, collecting interest from high-yield debt doesn’t sound like the safest type of investment. But Garrison Capital has put in a lot of effort to manage its risk.
As of March 31, more than 97% of the company’s portfolio consisted of first-lien senior-secured loans. As a first-lien lender, Garrison Capital Inc will be the first one standing in line to get paid if the borrower defaults and goes through liquidation.
Moreover, the company’s portfolio is well diversified. Garrison Capital currently has investments in 62 companies coming from more than 20 different industries. This means, if one company enters a downturn, the impact on Garrison Capital’s total financials will likely be limited.
And if you are worried about the rising interest rate environment, note that 99.4% of the company’s investment portfolio bears interest at floating rates.
Management estimated that with every 25-basis point increase in the London Interbank Offered Rate (LIBOR)—a benchmark interest rate charged when banks borrow from each other—Garrison Capital would earn an additional $0.01 per share of net investment income per quarter.
Therefore, if LIBOR goes up by 100 basis points—a possibility going forward, the company’s net investment income would increase by $0.04 per share per quarter, or $0.16 per share annually.
Even at the current interest rates, Garrison Capital still makes more than enough money to meet its dividend obligation. In the first quarter of this year, the company generated a net investment income of $0.31 per share while paying out total dividends of $0.28 per share, leaving a margin of safety. (Source: Ibid.)
A Value Proposition for Garrison Capital Inc
The best part is, despite offering a well-covered double-digit yield, GARS stock is not really expensive. By the end of March 2018, the company had a net asset value of $11.54 per share. And yet, Garrison Capital stock trades at just around $8.40 per share.
In other words, if the company’s net asset value hasn’t changed since the end of March, investors purchasing GARS stock today would be getting a 26.8% discount from its net asset value.
Adding in the company’s 13.3% dividend yield, Garrison Capital stock could be an opportunity for income-seeking investors.