Investors Should Pay Attention to BBDC Stock
With interest rates on the rise and money tight, now’s the perfect time to take a look at interest-sensitive stocks like business development companies (BDCs)—in particular, the reliable, high-yield dividend stock Barings BDC Inc (NYSE:BBDC).
Why?
BDCs operate in much the same way as traditional financial institutions. They borrow money at low interest rates and then lend it out at higher interest rates. Their profit, called the spread, comes from the difference between the interest they pay to creditors and the interest they receive from borrowers.
Like traditional banks, BDCs such as Barings BDC Inc have nationwide operations and provide loans to clients in various industries. Unlike big, impersonal banks, however, BDCs don’t serve the general public, and they have no branches or ATMs. They don’t provide mortgages, checking accounts, or credit cards.
Instead, BDCs loan out capital to small and midsized companies. By that, I mean companies that generate between $20.0 and $100.0 million in annual sales. BDCs like Barings BDC Inc lend money to their clients to fund acquisitions and growth projects, or to simply pay dividends to the owner(s).
Many well-known companies have benefitted from BDCs, including Etsy Inc (NASDAQ:ETSY), Facebook Inc, Lucid Group Inc (NASDAQ:LCID), and Smashburger, Inc.
This business model has several advantages.
Because their clients have few other options for borrowing money, BDCs can charge above-average interest rates. A commercial bank might earn as little as three percent from its loan portfolio. In comparison, a BDC might earn as much as 15%.
BDCs don’t just give out loans and then hope to get repaid; they also provide business advice, financial services, and other support to their portfolio companies.
BDCs usually have senior status on their loans. So, they stand first in line to get paid if something goes wrong. That lowers their default rate and allows their shareholders to sleep easy at night.
BDCs have less overhead than traditional banks. Running a bank branch isn’t free; the bank has to pay for land, the building, and maintenance. Never mind the salaries of all the tellers, managers, and support staff. BDCs, however, don’t have this problem. Without a branch network to keep humming along, almost every dollar they make in profits flows straight to their bottom line.
BDCs have less leverage than regular banks.
The U.S. government requires traditional banks to maintain a leverage ratio of five percent. In other words, for every $1.00 of capital they have in reserve, they can lend out $20.00. That explains why the financial industry needed such a large bailout from the Federal Reserve during the 2008 financial crisis. Without any financial cushion, even a few defaults can push a bank into insolvency.
BDCs, in comparison, must maintain a leverage ratio of at least 50%, meaning, for every $1.00 of capital they have in reserve, they can only lend out $2.00. This leaves BDCs with much less exposure in the event of an economic downturn.
Moreover, many BDCs are listed on public stock exchanges like the New York Stock Exchange or the Nasdaq. So, investors can buy and sell their shares just like with any other stock—and get quarterly (and sometimes monthly) dividends.
About Barings BDC Inc
Barings BDC is an externally managed BDC that primarily makes debt investments in middle-market companies. Its portfolio is focused on first-lien investments. The company’s investment advisor is Barings LLC. (Source: “Firm Overview: April 2023,” Barings BDC Inc, last accessed July 27, 2023.)
The BDC’s objective is to generate income by investing directly in privately held companies in a wide range of industries (e.g., manufacturing and distribution; business services and technology; transportation and logistics; and consumer products and services). Its investments help those companies fund acquisitions, growth, or refinancing.
Barings BDC Inc does this by investing in senior secured loans, first-lien and second-lien debt, equity co-investments, unitranche debt, and subordinated debt. It also specializes in mezzanine loans, leveraged buyouts, management buyouts, change-of-control transactions, acquisition financing, growth financing, and recapitalizations in lower-middle-market, mature, and later-stage companies.
The various kinds of loans sound like a garden salad, and some loans are more desirable than others. For instance, a BDC with 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 investment back in the event of a bankruptcy.
Total Investment Income Up 53% Year-Over-Year
For the three months ended March 31, 2023, Barings BDC reported total investment income of $67.2 million, up by 53% over its first-quarter 2022 total investment income of $43.8 million. (Source: “Barings BDC, Inc. Reports First Quarter 2023 Results and Announces Quarterly Cash Dividend of $0.25 Per Share,” Barings BDC Inc, May 4, 2023.)
Its 2023 first-quarter net investment after taxes was $27.5 million, or $0.25 per share, compared to $19.0 million, or $0.23 per share, in the same period of last year. The company also announced a net increase in net assets resulting from operations of $39.7 million, or $0.37 per share, compared to $21.0 million, or $0.25 per share, in the same period of last year.
Commenting on the quarter, Eric Lloyd, Barings BDC Inc’s CEO, said, “Despite ongoing uncertainty related to inflation, interest rates, and the broader economy, Barings BDC’s portfolio continues to deliver strong returns for our investors.” (Source: Ibid.)
During the first three months of this year, the company made 11 new investments totaling $65.8 million, made $33.9 million worth of investments in existing portfolio companies, and made a $45.0-million equity co-investment in one portfolio company.
In the first quarter, Barings BDC Inc also had four loans repaid totaling $26.6 million, received $12.7 million in portfolio company principal payments, received $9.1 million of return of capital from its joint ventures, and received $4.3 million in proceeds related to the sale of equity investments (recognizing a net realized gain of $1.0 million on those sales).
Barings BDC Stock’s Quarterly Distribution Increased to $0.25/Share
Thanks to its high first-quarter investment income, Barings BDC Inc was able to maintain its quarterly distribution at $0.25 per share in June, for a yield of 12.3%. (Source: Ibid.)
That’s far better than the current inflation rate of 2.9%.
The June dividend represents a 4.1% increase over the $0.24 that BBDC stock paid out in the same period last year. Furthermore, the company is on pace to distribute $1.00 per share on an annual basis, which would be 5.2% higher than the $0.95 it paid out in 2022. Barings BDC has raised its dividends each year since it paid out $0.54 per share in 2019. (Source: “Dividend History,” Barings BDC Inc, last accessed July 27, 2023.)
In addition to providing value to income hogs with reliable, growing, ultra-high-yield dividends, Barings BDC has a big share-repurchase program. On March 1, the company started a new 12-month, $30.0-million share-repurchase program.
Everyone loves a growing dividend, but it’s even better when it comes with a growing share price. After a year of declines, Barings BDC stock is starting to rally. As of this writing, shares of Barings BDC Inc are up by:
- 6.0% over the last month
- 11.8% over the last three months
- 5.4% year-to-date
BBDC stock has been doing a lot better than it was during the COVID-19 pandemic, up by 132% from its March 2020 low of $3.49. The stock is also up by approximately five percent over its pre-pandemic level.
The consensus on Wall Street is that shares of Barings BDC Inc will continue to rally, with analysts providing a median 12-month share-price estimate of $9.50 and a high estimate of $11.00. This points to potential gains in the range of 17% to 35%.
Chart courtesy of StockCharts.com
The Lowdown on Barings BDC Inc
Barings BDC is a lender with a diverse investment mix that’s primarily made up of first-lien loans. The firm’s overall debt is split roughly 50/50 between secured and unsecured debt.
In the first quarter, the company took advantage of the more lender-friendly environment, sourcing $145.0 million worth of new originations. Barings BDC Inc’s net investment income covered its high-yield dividend as its largely floating-rate portfolio yield increased on the heels of broad credit stability within its portfolio.
To its shareholders, the company pays reliably growing, high-yield dividends. Barings BDC stock’s quarterly distribution has climbed from $0.03 per share in the third quarter of 2018 to $0.25 per share in the second quarter of 2023. And, thanks to its high net investment income, it should be able to continue raising its dividends in 2024 and beyond.