An Overlooked High-Yield Opportunity?
Business development companies (BDCs) have been some of Wall Street’s best-kept income secrets. BDCs are generally in the middle-market financing business, earning oversized interest income in the process. They are also pass-through entities, meaning that, as long as a BDC distributes most of its profits to shareholders through dividends, it pays little to no income tax at the corporate level.
Because BDCs don’t serve consumers directly, most people have never heard of them. But due to the nature of their business, BDCs could be great yield-boosters for an income portfolio.
Take Monroe Capital Corp (NASDAQ:MRCC), for instance. The Chicago-based BDC is in the business of providing customized financing solutions to lower middle-market companies in the U.S. and Canada. With a market capitalization of around $219.0 million, Monroe Capital stock is not really big enough to make headlines in the financial media.
But this little-known stock could present a big-yield investment opportunity. The company currently follows a dividend policy that pays $0.35 per share every quarter. With MRCC stock trading at $10.74 apiece, the BDC offers investors an annual dividend yield of 13%.
The yield is backed by a lucrative lending business. As of September 30, the weighted average effective yield on Monroe Capital’s debt and preferred equity investments was 9.2%. (Source: “Monroe Capital Corporation BDC Announces Third Quarter 2019 Results,” Monroe Capital Corp, November 6, 2019.)
The company also has a senior secured lending focus. At the end of September, first lien loans comprised 89.9% of MRCC’s total portfolio. As a first lien lender, Monroe Capital would be the first one standing in line to get paid in the event of a borrower liquidation.
Is the Dividend Safe at Monroe Capital Corp?
This BDC reports its financials in a way that makes it easy for investors to see where things stand in terms of dividend safety. Every reporting period, the company reveals its net investment income. What risk-averse income investors want to see is a net investment income that’s greater than its dividend payout.
In 2018, Monroe Capital generated adjusted net investment income of $1.57 per share while paying $1.40 per share in total dividends. So the company outearned its dividends, leaving a margin of safety. (Source: “Monroe Capital Corporation BDC Announces Fourth Quarter and Full Year 2018 Results,” Monroe Capital Corp, March 5, 2019.)
In the first nine months of 2019, MRCC earned $1.05 per share in adjusted net investment income. Its dividend payments, on the other hand, also totaled $1.05 per share during this period. (Source: “Form 10-Q,” Monroe Capital Corp, November 6, 2019.)
So the payout was covered, but there was no room for error.
Personally, I’d like to see a stronger coverage. But I would also like to point out that the company has been doing a pretty good job at maintaining its payout.
You see, Monroe Capital stock went public in October 2012 and was a generous dividend payer right from the start; its initial quarterly dividend rate was $0.34 per share. The company raised the payout to $0.35 per share in 2015 and has been following that rate ever since. (Source: “Dividends and Distributions,” Monroe Capital Corp, last accessed December 24, 2019.)
If you’ve been following high-yield stocks, you’d know that, among the companies that yield 10% or more, dividend cuts are not uncommon. The fact that MRCC managed to maintain and increase its payout actually makes it stand out.
And even though there doesn’t seem to be enough margin of safety in the dividend policy lately, Monroe Capital does have a track record of covering its dividends.
When talking about MRCC’s financials in the company’s latest earnings conference call, Chief Executive Officer Ted Koenig said, “This represents the 22nd consecutive quarter we have covered our dividend with adjusted net investment income.” (Source: “Monroe Capital’s (MRCC) CEO Ted Koenig on Q3 2019 Results – Earnings Call Transcript,” Seeking Alpha, November 7, 2019.)