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Ares Capital Misses Estimates, Consolidates Yields in 2Q15

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Part 3
Ares Capital Misses Estimates, Consolidates Yields in 2Q15 PART 3 OF 7

Ares Capital in 2Q15: New Investment Focus Yields Better Returns

Investment performance

Ares Capital’s (ARCC) portfolio totaled $8.6 billion at fair value as of June 30, 2015. Its total assets stood at $9.1 billion. Ares Capital’s portfolio companies are performing well. The underlying corporate borrowers in its portfolio reported year-over-year EBITDA (earnings before interest, taxes, depreciation, and amortization) growth in the double digits at ~10%.

The company’s nonaccrual loans were unchanged in the second quarter, with 1.7% of the firm’s portfolio at cost and 1.3% of the portfolio at fair value on a nonaccrual basis as of June 30, 2015.

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As of June 30, 2015, the weighted average yield on the company’s debt and other income-producing securities at amortized cost increased to 10.6% from 10.5% as of March 31, 2015. The weighted average yield on total investments at amortized cost increased to 9.7% from 9.6% within the same time frame.

Higher yields at the cost of leverage

The weighted average total net leverage among Ares Capital’s corporate borrowers increased in the first half of 2015 from 4.8x on December 31, to over 5x on June 30, 2015. Accordingly, the weighted average interest coverage decreased in the second quarter of 2015.

Selling lower yield investments and building a portfolio with higher yielding debt comes with slightly higher risk. The increased leverage in the first quarter was driven by a combination of the company’s new investments and the sale of lower yielding first lien investments.

Ares Capital expects that the underlying corporate borrowers in the portfolio at the end of the quarter will deleverage from current levels, considering the positive 10% YoY (year-over-year) EBITDA growth of the portfolio companies.

Here’s the YoY revenue growth of peer companies in investment management:

  • Prospect Capital (PSEC) – 24%
  • BlackRock Capital Investment (BKCC) – 2%
  • Blackstone (BX) – 12%
  • KKR & Co. (KKR) – -8%

Together, these companies form 1.36% of the Financial Select Sector SPDR Fund (XLF).

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