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Ares Capital’s Valuation Gap Rose on Consistent Performance

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Dividend and repurchases

As of April 2016, Ares Capital’s (ARCC) stock had fallen by ~9% over the past year. The company is building up a portfolio of new partnerships and programs, resulting in a decline in average yields. The company paid a dividend of $0.38 per share, which was on par with the dividend paid the year before.

With a dividend yield of ~10% and improving portfolio yields, the company may provide better returns to its shareholders over the next few quarters. Here is how some of Ares Capital’s peers compare in terms of dividends:

  • Prospect Capital (PSEC): 13%
  • BlackRock Capital Investment (BKCC): 9.8%
  • Blackstone (BX): 7.2%
  • KKR & Co. (KKR): 8%

Together, these companies form 6.3% of the PowerShares Global Listed Private Equity Portfolio ETF (PSP).

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During the March quarter, Ares Capital repurchased a total of 393,056 shares of its common stock in the open market for $5.5 million under the stock repurchase program. The shares were repurchased at an average price of $13.94 per share. Ares Capital’s stable net asset value, higher investment income, and deployment of capital through new partnerships has provided good support for its stock price.

Fair valuations

Currently, Ares Capital is trading at 9.7x on a one-year forward earnings basis. Its peers are trading at 7x. Historically, the company has traded at a premium to its peers due to its quality portfolio and strategic partnership with GE Capital. The market tends to give a higher premium to investment management companies investing in debt when they have moderately leveraged balance sheets.

Investment management firms have experienced some yield compression over the past two years stemming from the low-interest rate environment. Ares Capital’s yields have declined in the current quarter due to the build up of its SDLP (senior development lending program) portfolio.

If Ares Capital can improve originations in the upcoming quarter with a similar or better yield profile, then shareholders may see higher investment and distributable income. The company’s recent joint venture with Varagon Capital Partners and AIG (AIG) could also provide Ares Capital with a strong platform for new originations.

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