This Company Offers a Jaw-Dropping Payout
If you want to earn an oversized dividend yield in today’s market, one group of stocks deserves a special look: business development companies (BDCs).
These companies tend to be in the financing business. In particular, a lot of them provide financing solutions to middle-market businesses in the United States.
Due to more stringent banking regulations put in place after the last financial crisis, traditional banks don’t always lend to middle-market companies anymore. As a result, midsized businesses have to pay higher interest rates to obtain financing.
Therefore, by lending to the under-served middle market, BDCs can collect a lot of interest income.
And there’s more: as long as BDCs distribute most of their profits to shareholders through dividends, they pay little to no income tax at the corporate level. The pass-through nature of BDCs has made them some of the highest yielders on the market.
For instance, New Mountain Finance Corp. (NYSE:NMFC), a BDC headquartered in New York City, pays investors a quarterly cash dividend of $0.34 per share. With NMFC stock trading at $13.40 per share, that quarterly payout translates to an annual yield of about 10.1%.
Like most BDCs, New Mountain primarily makes debt investments. It invests in debt securities at all levels of the capital structure, including first and second lien debt, unsecured notes, and mezzanine securities.
Notably, the company has a strong focus on senior secured debt. In the third quarter of 2019, 73% of NMFC’s originations were first lien debt. When someone is a first lien lender, they will be the first one standing in line to get paid in the event of a borrower liquidation. (Source: “Q3 2019 Earnings Presentation,” New Mountain Finance Corp., November 7, 2019.)
As of September 30, 56% of New Mountain’s portfolio by fair value consisted of first lien debt, and another 26% of the portfolio consisted of second lien debt. The company’s senior secured lending focus could help it generate a predictable stream of interest income.
The business is quite lucrative, as the current yield at cost of New Mountain’s portfolio was 9.8% at the end of the third quarter.
Another strategy that makes this BDC stand out is its focus on what it calls “defensive growth companies.” These are companies that exhibit some very favorable characteristics from an investor’s viewpoint, such as acyclicality, high barriers to competitive entry, high return on assets, niche market dominance, recurring revenue, strong free cash flow, and sustainable secular growth drivers. (Source: “Investment Strategy,” New Mountain Finance Corp., last accessed November 21, 2019.)
All of this looks good. But in order for New Mountain stock to be worth considering for income investors, there is still one question to ask: can the company make enough money to cover its payout?
Is the Dividend Safe at New Mountain Finance Corp.?
Like most BDCs, New Mountain reports something called net investment income. For a BDC’s payout to be considered safe in a given period, it needs to generate net investment income that is in excess of its dividends.
The good news is that this has been the case with NMFC. In 2018, the company earned net investment income of $1.40 per share. During the year, the BDC paid total dividends of $1.36 per share. So the company made more than enough profits to cover its payout. (Source: “New Mountain Finance Corp.oration Announces Financial Results for the Quarter and Year Ended December 31, 2018,” New Mountain Finance Corp., February 27, 2019.)
Fast forward to this year and we see that New Mountain earned a net investment income of $1.06 per share in the first nine months of 2019. During this period, the company paid three quarterly dividends totaling $1.02 per share. So the BDC managed to outearn its distributions. (Source: “New Mountain Finance Corporation Announces Financial Results for the Quarter Ended September 30, 2019,” New Mountain Finance Corp., November 6, 2019.)
Now, if you are a risk-averse investor, the payout ratio at New Mountain will seem a bit high. Ideally, we would want to see the company outearn its dividends by a wider margin. But here’s the thing: NMFC stock offers a yield of about 10.1%, and if you look around, you’ll see that, when it comes to double-digit yielders in the stock market, a company that can cover its payout is already a rare find.
Bottom line: I wouldn’t call New Mountain Finance Corp. a slam dunk, but for yield hunters, it’s one of the few names worth checking out.