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Strong Performance, Acquisitions Help Ares Capital’s Valuations

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Aug. 8 2016, Updated 10:05 a.m. ET

Dividends and repurchases

As of July 2016, Ares Capital (ARCC) stock has risen ~12% over the past six months. The company is building 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’s how some of Ares Capital’s peers compare in terms of dividends:

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

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

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During the June quarter, Ares Capital’s net investment income declined on a year-over-year basis on lower deployments. The company managed higher net realized gains, resulting in higher earnings per share. Its acquisition of American Capital (ACAS) will result in diversification toward retail loans.

Fair valuations

Currently, Ares Capital is trading at 9.8x on a one-year forward earnings basis. Its peers are trading at 8x. 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 that invest 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 buildup 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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