This is a series of articles to find BDCs to include in my updated "Total Return Portfolios" for Q3 2014. Please read "Part 1" for complete description of the portfolio but basically it is for investors that want dependable regular dividends and the potential for special dividends as well as long-term capital appreciation from increased stock values. The other four portfolios that I will cover in following articles are 'High Yield', 'Risk Averse', 'Value' and the 'Underdog' portfolios that will be updated on my "Portfolio Updates" page. This article will combine the portfolio growth and dividend coverage results from the articles listed below to discuss the potential for dividend increases.
- Part 1: Introduction
- Part 2: Historical & Potential Dividend Coverage
- Part 3: Portfolio Growth Potential
- Part 4: NAV Growth Potential
Portfolio Growth Potential
As discussed in "Part 3" of this series, portfolio growth potential without the need to issue additional shares is an indicator of how much a BDC can grow the current dividend by using cash and debt to purchase investments and increase net investment income ("NII"). The following table shows the portfolio growth potential for each BDC as of March 31, 2014 without the need to raise equity capital. However BDCs that have issued additional shares since the end of Q1 such as Fifth Street Finance (NYSE:FSC), Main Street Capital (NYSE:MAIN), Medley Capital (NYSE:MCC), New Mountain Finance (NYSE:NMFC) and Prospect Capital (NASDAQ:PSEC) have higher amounts of potential growth than listed in the table. I have placed each BDC into different categories based on the ability to have higher leverage due to SBIC licenses and/or higher quality assets to borrow against (please read Part 3 for more information).
Dividend Growth Potential
To estimate the amount of potential dividend growth over the coming quarters I account for the ability to grow the portfolio without issuing additional shares (measured in the previous table) along with historical dividend coverage. I have also included the results from my "optimal leverage" analysis that uses the current cost structure and capital expenses for each BDC, along with the amount of equity as of March 31, 2014 (or most recent), a debt-to-equity ratio of 0.80 and the current portfolio yield to project income and expenses. For more information on this approach to projecting dividend coverage, please read "BDC Dividend Coverage Part 1". I then averaged these measures of dividend coverage to come up with what I believe is the optimal amount of dividend growth available to each BDC. However the industry is experiencing yield compression as discussed in the dividend coverage series and I would expect to see companies taking a conservative approach to future increases and the BDCs with higher amounts of growth potential are much less likely to cut dividends in the future.
As you can see many of the BDCs that are currently in my total return portfolios are near the top including MAIN, TCP Capital (NASDAQ:TCPC), Hercules Technology Growth Capital (NASDAQ:HTGC), FS Investment Corp (NYSE:FSIC) and Ares Capital (NASDAQ:ARCC). NMFC and PennantPark Investment (NASDAQ:PNNT) rank lower from a dividend growth standpoint than the others but currently have the highest yields as well. I do not believe this is a coincidence. Triangle Capital (NYSE:TCAP) and Fidus Investment (NASDAQ:FDUS) continue rank higher as they have in previous analyses of this series and are serious contenders for these portfolios. As discussed in "Part 4" many of the BDCs with higher yields have less net asset value ("NAV") per share growth due to paying out a higher amount of gains and income such as PSEC, FSC, MCC, THL Credit (NASDAQ:TCRD) and TICC Capital (NASDAQ:TICC). These BDCs usually have less dividend growth potential for many of the same reasons with the exception of MCC which will be considered as well. KCAP Financial (NASDAQ:KCAP) and BlackRock Kelso Capital (NASDAQ:BKCC) are the only two BDCs that are likely to cut dividends and will not be considered.
The rest of this series will continue to look at historical results and projected performance of each BDC to uncover the best BDCs for this portfolio. The key criteria that I will be analyzing in upcoming articles are:
- Special dividend potential
- Relative valuations
- Risk to reward ratio
I will try to cover each of these areas using available public information as well as my own analysis and I will most likely be investing in all of these BDCs personally. Investors should only use this information as a starting point for due diligence and please see my frequently updated "Index to BDC Articles" for more information.
Disclosure: The author is long ARCC, FSC, FSIC, GBDC, HTGC, MAIN, NMFC, PFLT, PNNT, PSEC, TCPC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.