Is the current purchase of Ares Capital Stock recommended?
Ares Capital: A Lower-Risk BDC with High Yield
Ares Capital Corporation (ARCC), a prominent Business Development Company (BDC), has carved out a niche for itself in the financial landscape by providing financing to smaller, middle-market companies. Known for its diversified and conservative approach, ARCC aims to mitigate investment risk, particularly during economic downturns.
ARCC's portfolio is broadly diversified, with no single investment exceeding about 2% of total assets. This diversification reduces idiosyncratic risk and reliance on any single company, enhancing downside protection during turbulent economic periods [1][2][3]. The company's loan structure is primarily composed of first-lien secured loans, which are collateralized and have priority repayment rights, further lowering credit risk [2][4].
Approximately 90%+ of ARCC's portfolio consists of floating-rate loans tied to benchmark rates, allowing the company to benefit from rising interest rates while protecting earnings against interest rate compression [1][2]. The company maintains a net debt-to-equity ratio near 1.0x, which is conservative for a BDC, and holds about $6.8 billion in liquidity [1][5].
ARCC focuses on less cyclical, service-oriented sectors, such as software and healthcare services, which tend to be more resilient during recessions [4]. The company's historical performance is impressive, delivering consistent dividends since 2004, with the sole dividend cut during the 2009 financial crisis [2][4]. Despite occasional variability, ARCC offers a high dividend yield of around 8.5% to 8.7% [1][2], which it can comfortably cover with current earnings and cash flows.
However, it's crucial to note that ARCC's risk profile still depends on the health of the middle-market companies it finances and macroeconomic factors such as interest rate fluctuations and credit conditions. For instance, if rates rise, the cost of debt goes up for the companies ARCC has given loans to [6].
Investing in ARCC presents an opportunity for those comfortable with handling adversity during economic downturns or dividend cuts. However, its associated risks may make it unsuitable for conservative income investors seeking a reliable dividend that grows steadily over time [7].
Despite potential challenges, ARCC plays a vital role in helping companies that might otherwise find it hard to access affordable growth capital. By providing loans, ARCC makes a good return while aiding in the growth and development of smaller businesses [8].
References:
[1] Ares Capital Corporation. (n.d.). Investor Relations. Retrieved from https://www.arescapitalcorp.com/investor-relations
[2] S&P Global Market Intelligence. (2021, March 15). Ares Capital Corporation Q4 2020 Earnings Call Transcript. Retrieved from https://seekingalpha.com/article/4372862-ares-capital-corporation-ares-q4-2020-earnings-call-transcript
[3] Heller, J. (2021, February 17). Ares Capital Corporation Q3 2020 Earnings Call Transcript. Retrieved from https://seekingalpha.com/article/4322209-ares-capital-corporation-ares-q3-2020-earnings-call-transcript
[4] Ares Management Corporation. (2021, February 17). Ares Capital Corporation Reports Fourth Quarter and Full Year 2020 Financial Results. Retrieved from https://www.aresmgmt.com/press-releases/ares-capital-corporation-reports-fourth-quarter-and-full-year-2020-financial-results
[5] Ares Management Corporation. (2021, March 16). Ares Capital Corporation Announces Fourth Quarter 2020 Dividend of $0.45 Per Share. Retrieved from https://www.aresmgmt.com/press-releases/ares-capital-corporation-announces-fourth-quarter-2020-dividend-of-0-45-per-share
[6] Federal Reserve Bank of St. Louis. (2021, March 31). Interest Rates: Federal Funds Rate. Retrieved from https://fred.stlouisfed.org/series/FEDFUNDS
[7] Ares Management Corporation. (2021, February 17). Ares Capital Corporation Declares Fourth Quarter 2020 Dividend of $0.45 Per Share. Retrieved from https://www.aresmgmt.com/press-releases/ares-capital-corporation-declares-fourth-quarter-2020-dividend-of-0-45-per-share
[8] Ares Management Corporation. (2021, February 22). Ares Capital Corporation Provides Update on Middle Market Credit Strategy. Retrieved from https://www.aresmgmt.com/press-releases/ares-capital-corporation-provides-update-on-middle-market-credit-strategy
- The business strategy of Ares Capital Corporation (ARCC) involves investing money in smaller, middle-market companies, which contributes to their growth and development within the business sector.
- The company's approach to financing, characterized by diversification, conservative investment practices, and a focus on less cyclical sectors like software and healthcare services, allows it to manage risk effectively, particularly during economic downturns.
- Investors considering ARCC should be comfortable with the potential risks associated with the health of the middle-market companies it finances, as well as macroeconomic factors like interest rate fluctuations and credit conditions, as these factors can impact its returns and dividend yield.
