Garrison Capital Inc: This 13% Yielder Deserves an Upgrade
Should Income Investors Consider This High-Yield Stock?
In today’s market, most double-digit yielders are not perfect. Quite often, a company can offer an ultra-high yield only because of the downturn in its share price.
And that was pretty much the case for Garrison Capital Inc (NASDAQ:GARS). The company completed its initial public offering (IPO) in March 2013. But since the summer of 2015, its share price started going downhill. Trading at $8.56 apiece, GARS stock has a lot more than 40% of its value since IPO. Ouch!
Because dividend yield moves inversely to share price, the huge drop in GARS stock has made it one of the highest-paying companies in the current stock market. With a quarterly dividend rate of $0.28 per share, Garrison Capital offers a staggering annual yield of 13.1%.
In most cases, the reason behind a high-yield stock’s downturn lies in its dividend safety, or rather the lack of it. Think about it: if a company offers a safe payout that’s much higher than its peers, investors would rush to buy it, bidding up its price and lowering its yield.
So, since Garrison Capital has been offering a yield north of 10% for quite some time, it must mean that the payout is not safe, right?
Well, while the company wasn’t exactly known for its dividend safety, it has made some solid progress in recent months. And now, GARS stock deserves an upgrade.
A New Era for This Double-Digit Yielder
You see, last year, Garrison Capital generated net investment income of $17.2 million, or $1.07 per share. Since the company declared and paid total dividends of $1.12 per share during the year, it had a dividend coverage ratio of 95.5%. In other words, the company’s profits didn’t quite cover its dividend payments. (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.)
Most recently, though, things started to look much better. Garrison Capital reported earnings last month. In the first quarter of 2018, the company’s net investment income came in at $4.9 million, or $0.31 per diluted share. The amount was more than enough to cover its quarterly dividend payment of $0.28 per share. (Source: “Garrison Capital Inc. Declares Second Quarter 2018 Distribution of $0.28 Per Share and Announces First Quarter 2018 Financial Results and Earnings Call,” Garrison Capital Inc, May 8, 2018.)
In the first quarter, the company had a dividend coverage ratio of 110.7%, which actually left a margin of safety.
To give you a better idea of Garrison Capital’s progress, here’s a chart that shows the company’s net investment income and dividends for the past five quarters:
Garrison Capital Inc: Improving Dividend Coverage
Source: “Earnings Presentation,” Garrison Capital Inc, last accessed June 8, 2018.
As you can see, the first quarter of 2018 represented a big improvement for the company’s dividend coverage.
However, having a safer dividend is not the only reason why this high-yield stock deserves an upgrade. The company is also well-positioned to capitalize on rising interest rates.
Is the Best Yet to Come?
You see, Garrison Capital is an investment company. It provides financing solutions to middle-market businesses in the U.S. While the company has invested in a variety of loans, warrants, as well as equity securities, its primary focus is senior secured lending.
In fact, by the end of the first quarter of 2018, first-lien loans represented 97.2% of Garrison Capital’s portfolio. Therefore, the company makes most of its money from collecting interest payments on these loans.
Here’s the best part: over the years, Garrison Capital has transformed its portfolio to benefit from the rising interest rate environment.
Today, 99.4% of loans in the company’s debt portfolio bear interest at floating rates. Management estimated that if the benchmark interest rate goes up by 25 basis points, Garrison Capital would earn an extra $0.01 per share of net investment income.
Also, keep in mind that Garrison Capital chooses to be regulated as a business development company. Therefore, the company is required by law to distribute at least 90% of its profits to shareholders in the form of dividends.
Interest rates have already been rising. With multiple rate hikes expected from the U.S. Federal Reserve, Garrison Capital could generate higher interest income going forward. And thanks to the company’s mandatory distribution requirement, those future rate hikes could translate to dividend hikes for GARS stock investors.
At the end of the day, you can find companies with safer dividends than Garrison Capital Inc. But with a double-digit payout and improving financials, the company is now worth considering for yield-seeking investors.