Main Street Capital (NYSE:MAIN) closed Tuesday at a 5.29% yield based on its March dividend. All of the stats in the spreadsheets that will follow are based on the Q1-13 dividend. MAIN has already declared an increase in its Q2-13 dividend. The sector average of dividend-paying BDCs in my coverage universe was 8.82%. MAIN also sells at a lofty valuation based on Price/NAV and its P/E ratio.
It is my theory that all income stocks sell at something close to logical yield plus CAGR (or projected dividend Compound Annual Growth Rate), with adjustments for dividend security and the confidence the market has in the CAGR projection. For MAIN to be selling at a correct or low valuation (and thus be worthy of your purchase), I will need to provide evidence that it merits a significantly higher dividend CAGR projection than the average BDC. It would help if MAIN's NII projection merits more than an average level of confidence. I believe the case can be made for both arguments.
In Dividend Growth Is The MAIN Thing Part One, I provided a metric-intensive update on the Q4-12 MAIN earnings release and provided a top down NII projection. In part two, I will show the 3-12-13 performance and valuation spreadsheets for the BDC sector and discuss MAIN's valuations.
Yield in the spreadsheet below is based on the Q1-13 dividend. Spreadsheet header abbreviations: Div = dividend; EPS = earnings per share; LTM = last twelve months; YTD = year to date. bps = basis points. The dividend-to-EPS ratio is a measure of dividend safety. The dividend-to-NAV ratio is a measure of safety and efficiency. The last four columns measure the percentage change in the 2013 EPS projection and the change in the price target since the beginning of the year; the change in the Q1-13 dividend from the Q1-12 dividend; and the change in the Q4-12 NAV from the Q4-11 NAV. Some BDCs have already started declaring Q2-13 dividends. MAIN is the only BDC to declare an increase in its Q2-13 dividend.
|Share Price||Div/||Div/||Q4-12||Price||YTD Percent Change||LTM||LTM|
|With the 10-year Treasury at 2.02% and sector average yield (on Q1 dividends) at 8.82% - the spread is 680 bps|
|The cap-weighted ETF BDCS is up 7.09% year to date - with dividends its return is 8.96%|
|Average yield and average Dividend-to-EPS ratio were divided by 28, not 30, to filter out the effect of the zero payout ACAS and SAR|
|Weeding out ACAS and SAR, the average share price gain is 6.66%|
Dates used to credit dividends:
|ACAS : none||AINV : 01-03-13||ARCC: 03-29-13||BKCC: 04-02-13||FDUS: 03-28-13||FSC : monthly||FULL: monthly|
|GAIN: monthly||GLAD;: monthly||GBDC;: 03-27-13||HTGC: 03-19-13||HRZN: 03-14-13||KCAP: 01-27-12||KED : 01-31-13|
|MAIN: monthly||MCC: 03-13-13||MCGC: 03-29-13||NGPC: 01-06-13||PFLT: monthly||PNNT : 04-01-13||PSEC: monthly|
|SAR: none||SLRC: 04-02-13||SUNS: monthly||TAXI : 03-28-13||TCAP: 03-27-13||TICC : 12-28-12||TCRD: 01-27-13|
BDC Earnings Growth & P/E Ratios 03-12
Fiscal and calendar years are not always in sync. BDCs than began fiscal 2013 on or before calendar Q3-12 include AINV, FULL, GAIN, GBDC, GLAD, MCC, PSEC, PFLT, and PNNT. The range metric is the high estimate minus the low estimate, with that result dividend by the consensus estimate - and serves as one of several measurements for assessing risk. All EPS projections are from Yahoo Finance.
|Earnings / Share||Earn. Growth||P/E Ratios||13 EPS Range|
Discussion of MAIN's Valuations
Just in case the numbers from part one went by you in a blur, let me repeat two of those numbers: Total Investment Income of $26.165 million ($0.8102/share) and Net Investment Income of $18.128 million ($0.5614/share). The NII/TII ratio was 69.28%! The sector average for BDCs is in the mid 50s. MAIN has had NII/TII ratios over 60% in every single quarter this year and the last two quarters of 2011.
Why does that matter to you?
Dividends are paid out of NII. For each dollar of TII produced, MAIN is generating much more than average NII. Along with KED and TCAP (and recently KCAP), MAIN is one of the best in the sector on this metric. This efficiency leads to NII growth. And NII growth leads to dividend growth. It is not a coincidence that three of these four are internally managed BDCs - an attribute that is currently leading to lower fees and higher efficiency. I have no bias against externally managed BDCs until that attributes starts showing up in the numbers. At this point in time, the numbers are saying that this attribute matters.
The attributes I want in a BDC are (1) a well covered dividend; (2) growing NII/share; (3) growing NAV/share; and (4) a growing dividend/share. MAIN has all of those. Do the numbers indicate if those conditions will continue?
I will start by building a short-term CAGR projection. Q1-12 over Q1-11 dividend growth was (0.150/0.135) 11.11% while Q2-13 over Q2-12 dividend growth is (0.155/0.140) 10.71%. Calendar year 2011 dividend growth over 2010 was 8.00%. There is at least a very high single digit trend in dividend growth. For the NII, growth was (1.69/1.00) 69.00% in 2011; (2.01/1.69) 18.93% in 2012; and is projected to grow [2.04/2.01] 1.49% in 2013 (remember - I expect the current NII projection is too low) and (2.20/2.01) 9.45% in 2014. There is room in the Dividend/NII ratio for dividend growth to exceed NII growth in 2013. For NAV, 2012 growth was (18.59/15.19) 22.38% and (15.19/13.06) 16.31% in 2011. With the general market off to a good start, this should assist in relatively equity heavy MAIN having a good 2013. The current (1.86/2.04) 91.18% payout ratio suggests middle-single-digit dividend growth in 2013. Using my NII projection, a payout ratio of (1.86/2.10) 88.57% suggests high-single-digit dividend growth. As a general rule, I do not use or trust the EPS CAGRs found at Yahoo due to the overly generous projections for what look to be near zero dividend growth BDCs. In the case of the consensus projection for MAIN, the 5 year CAGR is 7.00% - which makes it an atypically logical projection in my opinion.
I am conservative when it comes to my CAGRs - and I use a 6.5% CAGR for MAIN. If I am making an error, it is probably in making the projection too low. With a current yield of 5.29% - the yield plus CAGR metric is 11.79%. Factor in a projection for more special dividends, and that metric grows some more. MAIN's current projection (provided in the Q4-12 conference call) is for a 2013 special dividend of "at least" $0.40/share. Add that to $1.86/year April dividend run rate and the yield rises to 6.64%. Using that adjusted yield, the "yield plus CAGR" rises to 13.14%. Most BDCs have "yield plus CAGRs" in the 11s - and only one other BDC has a metric in the 13s.
Now let us talk about risk. The historical accuracy of MAIN's EPS projections is superior to those of most BDCs. Errors have recently tended to be in MAIN having beginning-of-the-year EPS projections that are too low. With a spread of 2013 EPS projections (high estimate minus low, with that result divided by the consensus) at 9.31%, the spread indicates average risk. The portfolio debt/EBITDA and interest coverage ratio metrics for MAIN are the best in the sector (data that was provided for the Lower Middle Market portfolio only) - and this is an indicator of very low risk. The weighted average yield for the Lower Middle Market is 14.2% - and this suggests higher than average portfolio risk for the Lower Middle Market portion. The Middle Market portfolio has an 8.8% weighted average yield - which is an indicator of low risk. With MAIN's debt/NAV at 53.41%, its leverage indicates average to lower than average risk. Both of MAIN's portfolios are heavy in senior secured loans - the safest kind of loan. At fair value, MAIN has zero loans on non-accrual - another very low risk indicator. MAIN has no publicly traded debt to generate a risk level based on that attribute. With a yield on the credit facility at LIBOR plus 2.5%, this is another metric that suggests that MAIN's risk level is average or below average. With investments in 144 portfolio companies, the MAIN portfolio is granular or diversified - another lower risk metric. Two metrics indicated average risk; seven indicated low risk; and one indicated high risk. In total, MAIN has the metrics of a lower risk BDC.
The P/E ratio based on the 2013 EPS projection is 16.68 compared to a sector average 11.12. That comparison is enough to scare you away from MAIN. The Q4-12 based price to NAV ratio for MAIN is 1.83 compared to something close to 1.20 for the sector average. That comparison should also scare you. But BDCs (and all income stocks) sell at a logical 'yield plus CAGR' metric. And it is MAIN's high CAGR that more than justifies its atypical P/Es and Price/NAVs.
Most of my investments have "yield plus CAGRs" in the 10s and 11s. But most of my investments are in sectors with lower risk than BDCs. I do have a few 12s (and a few even higher). I can get excited about a 13. Add to that, most of my high "yield plus CAGR" stocks have yields under 3%. So I can even get excited about MAIN's over 5% yield. At these current valuations, I believe MAIN is a buy. I believe it is a buy and hold as long as the "yield plus CAGR" projection is over 9.
So if MAIN is a buy, where should one buy it?
Your Asset Location Decision
Because most BDCs have a payout that is overwhelmingly taxed as income, it is good tax planning to put your holdings in this sector in a tax deferred vehicle like an IRA. MAIN is atypical in that a larger share of its payout qualified for taxation as long-term capital gains. For 2012, 46% of MAIN's dividends will be taxed as long-term capital gains. For 2011, 26% of the payout qualified. This taxation attribute gives you flexibility in your asset location decision. I will probably regret not putting MAIN in my Roth.
I do not believe that the market will find justification for MAIN to sell at a yield much below 5%. I would not be surprised if the yield never falls below 4.75%. I think MAIN will attain share price appreciation only as it grows its dividend. But I expect dividend growth for MAIN to continue to far outpace the growth for the sector.
It will take some patience and some time to harvest big gains for MAIN. I believe MAIN is worthy of your patience. But time can also change the valuation metrics. I strongly believe that all BDCs are due diligence intensive stocks. This also means that your maintenance level due diligence on MAIN will need to remain high.