Is This Double-Digit Yield Too Good to Be True?
In recent years, income investors didn’t really have much of a choice. You either had to go with a blue-chip stock with a low dividend yield or a high-yield stock that may or may not be able to afford its payout.
Garrison Capital Inc (NASDAQ:GARS) falls into the latter category. The company offers a jaw-dropping yield of 12%, but isn’t exactly known for its dividend safety.
You see, Garrison Capital Inc is an investment management company that chooses to be regulated as a business development company (BDC). Headquartered in New York City, the company invests primarily in loans to middle-market businesses in the United States.
Those who follow my column would know that we cover plenty of BDCs here at Income Investors. These entities act as pass-throughs: they pay little to no income tax at the corporate level, as long as they return most of their profits to shareholders in the form of dividends. As a result, BDCs have become some of the highest yielders in today’s market.
A Generous Dividend Policy, But a Not Perfect One
Garrison Capital has had a generous dividend policy from the start. When the company went public in March 2013, it had a quarterly dividend rate of $0.35 per share. Based on where GARS stock was trading at that time, the company was yielding over nine percent.
The thing is, though, the company didn’t always generate enough profits to cover the payout. And as we have seen plenty of times, paying more than what you earn leads to one thing: a dividend cut.
And that happened in November 2016, when the company reduced its quarterly dividend rate from $0.35 per share to $0.28 per share—a 20% cut. (Source: “Dividends & Distributions,” Garrison Capital Inc, last accessed November 14, 2018.)
A lower dividend burden certainly gave Garrison Capital more breathing room, but the magnitude of that cut might not have been enough. In 2017, the company earned a net investment income of $17.2 million, or $1.07 per share. Its dividends, on the other hand, totaled $1.12 per share. (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.)
In other words, Garrison Capital’s profits still did not cover its dividends.
Could the Latest Dividend Cut Be Good News?
Unsurprisingly, the company had to cut its payout one more time. In November 2018, Garrison Capital’s board of directors declared a cash distribution of $0.23 per share for the fourth quarter of 2018. The amount represented a 17.9% reduction from GARS stock’s previous dividend payment.
However, note that in the third quarter of 2018, Garrison Capital generated a net investment income of $3.7 million, or $0.23 per share. If the company can keep earning this amount or more, it would be able to cover its new dividend rate. (Source: “Garrison Capital Inc. Declares Fourth Quarter 2018 Distribution of $0.23 Per Share and Announces Third Quarter 2018 Financial Results and Earnings Call,” Garrison Capital Inc, November 6, 2018.)
In the company’s latest earnings conference call, Garrison Capital’s Chief Executive Officer Joseph Tansey said: “We have announced the fourth quarter dividend of $0.23 per share and we believe it’s fully aligned with our updated earnings projections based on our more cautious view of direct lending space and our more conservative credit underwriting guidelines.”
After reviewing Garrison Capital’s current strategy, Chief Financial Officer Brian Chase added, “To that effect, we believe the new dividend level is both achievable and sustainable in the current market conditions.” (Source: “Garrison Capital (GARS) CEO Joseph Tansey on Q3 2018 Results – Earnings Call Transcript,” Seeking Alpha, November 8, 2018.)
A New Catalyst for Garrison Capital Inc?
Another thing I want to point out is the company’s focus on making floating rate investments. As of September 30, floating rate loans represented 99.6% of Garrison Capital’s portfolio.
Management estimated that if the benchmark interest rates go up by 100 basis points, Garrison Capital would earn an extra $3.7 million in annual interest income while its interest expense would go up by just $1.6 million. The net effect under such a scenario would be a $2.1-million increase to the company’s annual net investment income. (Source: “Form 10-Q,” Garrison Capital Inc, November 6, 2018.)
The U.S. Federal Reserve is expected to enact one more rate hike in 2018, and three for 2019. In the current rising interest rate environment, Garrison Capital could see its bottom line improve.
With a reduced dividend rate and a catalyst for higher profits in the future, Garrison Capital’s 12% dividend yield might be worth a look.