Barings BDC Stock: 11%-Yield Alternative Bank Stock Thumping the Market
March 20, 2024
Why BBDC Stock’s Dividends Can Keep Rising
Investors are hanging their hopes on the Federal Reserve beginning to cut its decades-high interest rates.
But strong economic growth has seen the odds of a rate cut happening in the first half of this year fall to 58% (according to the fed funds futures market). In December 2023, the odds of at least one rate cut happening in the first half of 2024 stood at 75%. (Source: “Morning Bid: Some China Cheer as Central Banks Enter the Starting Gates,” Reuters, March 18, 2024.)
And while most investors and analysts initially expected the Fed’s interest rate cuts to come at a fast clip, they now expect the cuts to arrive more slowly. In February, the stock market was pricing in more than five interest rate cuts this year. Now, it’s pricing in just three cuts in 2024.
Without any economic weakness, the Fed has no reason to start cutting rates anytime soon. Nor does it have any reason to ramp up the number of rate cuts to make up for lost time. For cash-strapped consumers, that’s not great news. On the other hand, barring some unforeseen events, it appears that the U.S. will avoid the long-promised recession.
Even when interest rates start coming down, they’re expected to remain well above their pre-pandemic levels for years. That’s good news for business development companies (BDCs), or as we call them here at Income Investors, “alternative banks.” That includes Barings BDC Inc (NYSE:BBDC).
Barings BDC is an externally managed BDC that primarily makes debt investments in middle-market companies with earnings before interest, taxes, depreciation, and amortization (EBITDA) of $10.0 to $75.0 million. (Source: “Barings BDC Investor Day,” Barings BDC Inc, October 4, 2023.)
While some investors might think bigger is better, when it comes to BDCs, it isn’t always the case. According to Barings BDC, core middle-market deals have “lower leverage, tighter documentation, and better covenants” than big corporate deals.
The default rate on investments under $100.0 million is just 1.33%, the default rate on deals of $250.0 to $499.0 million is 5.14%, and the default rate on investments of $500.0 million or higher is 5.47%.
Barings BDC Inc’s investment objective is to generate income by investing directly in privately held middle-market companies in a wide range of industries (e.g., business services, health care, manufacturing, software, and transportation) to help those companies fund acquisitions, growth, or refinancing.
It does this by making senior secured, first-lien, second-lien, mezzanine, equity, joint venture, and structured loans.
The various kinds of loans sound like a garden salad, and some loans are more desirable than others. For instance, a BDC with a lot of “senior” debt stands first in line to get its money back. “Mezzanine” lenders get paid second. Meanwhile, “preferred” and “equity” lenders usually receive only a fraction of their original investments back in the event of a bankruptcy.
Of Barings BDC Inc’s $2.51-billion investment portfolio, 74% is made up of senior secured debt and 90% has floating interest rates.
Q4 Net Investment Income Exceeded Dividends
For the fourth quarter of 2023, Barings BDC reported total investment income of $75.8 million, net investment income of $33.4 million ($0.31 per share), and a net increase in net assets resulting from operations of $29.9 million ($0.28 per share). (Source: “Barings BDC, Inc. Reports Fourth Quarter and Full Year 2023 Results and Announces Quarterly Cash Dividend of $0.26 Per Share,” Barings BDC Inc, February 22, 2024.)
During the fourth quarter, the company made a total of $100.9 million in 14 new investments, $79.1 million worth of investments in existing portfolio companies, and $12.5 million in an equity co-investment (alongside certain affiliates) in one portfolio company.
Also in the fourth quarter, the BDC had seven loans repaid, totaling $64.8 million, and received portfolio company principal payments of $37.2 million.
Commenting on the results, Eric Lloyd, Barings BDC Inc’s CEO, said, “In the fourth quarter, we out-earned the dividend by approximately 20%, increased net investment income from the third quarter and repurchased 449,096 shares as part of our share repurchase program.” (Source: Ibid.)
For the full year, Barings BDC Inc reported total investment income of $289.2 billion, net investment income of $127.8 billion ($1.19 per share), and a net increase in net assets resulting from operations of $128.0 million ($1.20 per share).
Management Declared March Dividend of $0.26 Per Share
Shares of BDCs are a great vehicle for passive income investors. Because of their unique tax structure, BDCs can elect to be taxed as regulated investment companies. This exempts them from corporate income tax, but only if they distribute at least 90% of their profits to their shareholders, typically as dividends.
Thanks to its high net investment income, Barings BDC Inc is able to provide investors with reliably growing, high-yield distributions.
In February, management declared a dividend of $0.26 per share, which was paid on March 13. (Source: “Dividend History,” Barings BDC Inc, last accessed March 18, 2024.)
As of this writing, that translates to a yield of 11.27%, which crushes the current U.S. inflation rate of 3.15%.
Whereas some companies only increase their payouts on an annual basis, when times have been good, Barings BDC has done it multiple times within a year. The company increased its dividend every quarter in 2021 and raised it twice in 2022 and 2023.
Barings BDC Stock Recently Hit Record High
In addition to providing value to passive income investors with growing, high-yield dividends, Barings BDC Inc has a large share repurchase program. In the fourth quarter of 2023, the company repurchased 449,096 of its own shares. In February 2024, the board authorized a new 12-month, $30.0-million share repurchase program. (Source: Barings BDC Inc, February 22, 2024, op. cit.)
Growing dividends and an aggressive share repurchase program are great ways to provide investors with value, but so too is a growing share price. On February 28, BBDC stock hit a new all-time record intraday high of $9.89 per share. It has retraced a little since then, but it’s still trading near $9.17 per share.
As of this writing, Barings BDC stock is up by 10% year-to-date and 34% year-over-year. Over the same two time frames, the S&P 500 is up by 8.1% and 30.2%, respectively.
Chart courtesy of StockCharts.com
The Lowdown on Barings BDC Inc
Barings BDC’s lending portfolio has a diverse funding mix, primarily made up of first-lien investments.
In the fourth quarter of 2023, the company took advantage of the lender-friendly environment, sourcing $100.9 million worth of new loan originations. Its net investment income in the quarter covered BBDC stock’s high-yield dividend by $0.05 per share.
In the first quarter of 2024, the company improved its liquidity position and financing profile through the issuance of $300.0 million in five-year unsecured notes at a 7.0% coupon. That unsecured debt increases Barings BDC Inc’s operational stability and allows it to optimize its liability structure and expand its ladder of maturities out to 2029.
