Bauhaus1000
Main Street Capital (New York Stock Exchange: Main) is one of the best business development (BIZD) companies on the market today, having achieved market-beating total returns over the long term, along with strong earnings growth. In addition, it is supported by An investment-grade balance sheet with relatively low leverage and internal management gives it significantly lower operating costs than the vast majority of its peers. Furthermore, its management owns more than 4% of the company’s shares, making it well aligned with shareholders. Furthermore, it has strong underwriting performance with relatively low non-accrual rates, despite investing in a portfolio with a more robust position than many of its peers, such as the Blackstone Secured Lending Fund (BXSL), Blue Owl Capital (I love you), Golub Capital BDC (GBDC). Perhaps most impressive is that it has generated The average annual return on equity is 13.7% from 2010 to 2023. This impressive set of credentials makes it one of the leading investment companies. Really special business development companies It has enabled it to command a rich premium to its net asset value, further accelerating its growth by enabling it to issue shares on a highly accretive basis and reinvest those shares in investments that help it continually grow its net asset value per share and its earnings.
However, there has been some bad news recently for Main Street Capital, which we will discuss in this article.
Bad news for major stocks
The first bad news is that the sector is dealing with significant and growing competition with several major asset managers pumping capital into the space. This includes Blackstone (BX), Brookfield (BAM) (BN), Blue Owl (OWL), Ares (ARES), Apollo (APO), KKR (KKR), Carlyle (CG), BlackRock (BLK), and even the likes. JPMorgan (JPM) and Goldman Sachs (GS). What this means is that with so much money chasing a limited number of deals, borrowers in this space have increasingly strong negotiating positions and are able to obtain more attractive terms and/or interest rates on new loans, thus reducing the risk and reward for averages. . Market investors like Main Street Capital.
Additionally, Blue Owl Capital, one of the largest investors in direct lending, has fallen significantly over the past few days due to Jamie Dimon expressing some concerns about the sector. For example, he noted, “I saw a couple of these deals that were rated by a rating agency, and I have to admit, I was shocked by what I got. So it reminds me a little bit of mortgages.” He went on to say, “Not all people who do this are good, and problems in financial markets are often caused by ‘not good’ people, people who make mistakes.”
Another cause for concern is that the US economy is facing an environment in which consumer spending will likely begin to slow soon because excess savings from the coronavirus stimulus have been fully exhausted, the unemployment rate has been steadily rising and approaching 4%, and defaults and delinquencies are beginning to rise. Across the business and personal consumer sectors of the economy. With interest rates likely to stay higher for longer, this could pose a problem for middle market lenders like Main Street Capital. Its own loans are largely floating rate and will therefore remain at high interest rates, while its investments in floating rate loans may struggle to remain current as many middle market counterparties begin to see their liquidity stretched by rising costs. Continuous inputs due to inflation and monetary policy. The cost of servicing their debt rises because short-term interest rates stay higher for longer. As the CEO of Ares Capital (ARCC) recently said:
We are likely to see an increase in defaults in the industry this year. You have some companies that are making interest payments but continue to live off the availability of revolvers, cash, etc., but liquidity is getting tighter, so my expectation is that defaults will go up this year.
When you combine all of these growing threats to Main Street Capital’s fundamentals with the fact that it is currently priced at a significant premium to its net asset value as well as its historical average price to net asset value, it appears that Main Street Capital is at risk of suffering. Poor physical performance moving forward.
Investor takeaways
What does this mean for investors? Although we don’t believe the dividend is at risk right now, we view Main Street Capital as likely not achieving a significant capital appreciation from this point going forward. Although it should still be able to issue shares on a cumulative basis unless there is a massive collapse in its share prices, we do not see any further pickup in earnings power from raising interest rates in the short term because we believe the Fed is likely to raise interest rates. Benefit. Furthermore, we expect outstanding amounts to rise as counterparties continue to come under pressure. We also see opportunities for attractive new investments to dry up significantly given the increased competition in this space, and therefore do not expect enhanced earnings to be a major part of the investment thesis going forward.
Additionally, we view multiple valuation contraction as a more likely scenario than forward expansion, which would constitute another headwind to total returns. As a result, we see that the dividend, which is good at 5.75% right now, will likely be offset by multiple valuation contraction, and we see little additional per-share growth for the foreseeable future, although there may be a bit of growth on Near term. . As a result, we don’t see Main Street Capital as likely to generate more than mid-single-digit annualized total returns going forward, and depending on what happens with the economy and sector sentiment at BDC, we see Main Street Capital’s total returns likely to come close of zero or even negative over the next several years.
As a result, we classify the stock as a hold and do not recommend anyone invest in it unless they already have significant capital gains and are holding it simply for earnings growth. In this scenario, we think it is perfectly fine to continue holding it, as we are not necessarily bearish on the stock. However, we are very cautious about increasing bad sector news impacting Main Street Capital. Despite being one of the leading blue chip companies, it is priced to perfection and therefore we believe that investors in Main Street Capital may have a false sense of security by looking at its historical quality without realizing that they can still incur significant losses due to… Decreased valuation premium.
