Monroe Capital Corp: Beaten-Down Stock Offers a 10.5% Annual Yield
Should Income Investors Consider This High-Yield Stock?
Today I highlight one of my favorite places to find high-yield opportunities: out-of-favor stocks.
When an investor purchases a dividend stock, the yield they lock in is calculated by dividing the company’s annual cash payout by its share price. Therefore, at the same cash dividend rate, a company’s dividend yield moves inversely to its share price.
In other words, if you want to lock in a high dividend yield, going after the hottest tickers may not be the best strategy. Beaten-down stocks, such as Monroe Capital Corp (NASDAQ:MRCC), can sometimes offer much more substantial yields.
Headquartered in Chicago, Illinois, Monroe Capital Corp is a closed-end investment management company that’s structured as a business development company (BDC). It provides financing solutions primarily to lower middle-market businesses in the U.S. and Canada.
When Monroe Capital Corp completed its initial public offering (IPO) in 2012, its initial quarterly dividend rate was $0.34 per share. In 2015, the company raised its quarterly payout to $0.35 per share. (Source: “Dividends & Distributions,” Monroe Capital Corp, last accessed February 22, 2018.)
While the company’s dividend went up, its stock price did not. In just the last 12 months, shares of MRCC stock have tumbled more than 15%.
As I mentioned earlier, there’s an inverse relationship between a company’s dividend yield and its stock price. So, unsurprisingly, Monroe Capital Corp’s yield has gone up. In fact, trading at $13.16 apiece, MRCC stock currently offers a staggering annual yield of 10.65%.
To give you some perspective, the average S&P 500 company pays just 1.8% at the moment. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed February 22, 2018.)
Of course, stocks often drop for a reason. In the case of ultra-high yielders, the most common reason behind a stock’s downturn is investors’ concerns about the company’s dividend safety.
So, should that be a concern for investors of MRCC stock?
Well, according to Monroe Capital Corp’s most recent earnings report, the company generated adjusted net investment income of $7.0 million, or $0.35 per share in the third quarter of 2017. It also declared and paid total dividends of $0.35 per share during this period. So the company did make enough money to cover its payout, but didn’t leave any room for error. (Source: “Monroe Capital Corporation BDC Announces Strong Third Quarter Financial Results,” Monroe Capital Corp, November 7, 2018.)
Looking a bit further back, you’ll see that Monroe Capital Corp’s adjusted net investment income has covered its dividend payment for 14 consecutive quarters. (Source: “Company Overview December 2017,” Monroe Capital Corp, last accessed February 22, 2018.)
High Dividend Backed by a Solid Business
The reason that the company can cover its oversized dividends lies in the nature of its business. While Monroe Capital Corp invests in both debt and equity securities, its focus is secured lending.
By the end of September 2017, approximately 86.5% of the company’s portfolio was comprised of first lien secured loans. When you invest in first lien debt, you will be the first in line to get paid if the borrower defaults and goes through liquidation. With most of its portfolio invested in the first lien secured loans, Monroe Capital Corp can generate a steady stream of interest income.
At the same time, the portfolio is well-diversified. As of September 30, 2017, Monroe Capital’s portfolio consisted of 118 loans and 17 equity securities across 66 portfolio companies. These companies come from more than 10 different industries.
MRCC’s biggest industry exposure, Healthcare & Pharmaceuticals, accounted for just 15% of its total portfolio’s fair value. This means if one company or one industry enters a downturn, the negative impact on the portfolio-level income stream will likely be limited. (Source: Ibid.)
Moreover, while many companies are worried about higher interest rates in the future, Monroe Capital Corp would actually turn that into a catalyst. This is because the majority of the loans in the company’s portfolio have floating interest rates. Management estimated that if the London Interbank Offer Rate (LIBOR)—a benchmark rate at which banks lend to each other—increases by 200 basis points, the company would earn an extra $7.9 million in interest income per year. And because most of its liabilities bear interest at fixed rates, its annual interest expense would only go up by $1.2 million. (Source: “Form 10-Q,” Monroe Capital Corp, last accessed February 22, 2018.)
Therefore, a 200-basis-point increase in benchmark interest rates would allow Monroe Capital Corp to generate an additional $6.7 million a year in net investment income. That would be quite a sizable increase, given that the company’s net investment income for 2016 was $22.5 million.
Still, I wouldn’t call MRCC a slam dunk. As a conservative income investor, I would like to see a higher dividend coverage ratio from this specialty finance company. But if the company can deliver on its estimates when interest rates goe up in the future, its 10.5% dividend yield will definitely be worth a look.