MRCC Stock: Consider This High Yield
The past several years haven’t been the nicest to income investors. The most solid dividend-paying companies were already expensive. That means they don’t offer much in terms of yield, while the high-yield stocks weren’t exactly known for their dividend safety.
That’s why many investors have been digging into the out-of-favor sectors of the stock market, hoping to find high-yield gems hidden in the dark.
It’s not easy. A beaten-down stock may offer a substantial payout, but if its business is not sound—which often happens to be the case for an out-of-favor company—that payout would not be sustainable.
As long-term investors, you don’t want to buy a stock before its dividend gets cut. Still, every once in a while, we come across an ultra-high yielder that can actually afford its payout.
Case in point: Monroe Capital Corp (NASDAQ:MRCC) is a beaten-down stock that many investors have never heard of. Headquartered in Chicago, the company’s share price plunged more than 20% over the last three months.
We know that, at a given cash dividend rate, a company’s dividend yield moves inversely to its stock price.
MRCC stock was already a high-yield one before the recent drop in its share price. And since the company kept its dividend rate constant during this period, this stock price pullback has pushed its yield up to a jaw-dropping level of 14.0%.
Monroe Capital Corp
Now, you are probably wondering how a company could afford this kind of payout.
Well, the answer lies in its lucrative lending business.
Monroe Capital Corp is a business development company (BDC) that provides financing solutions to lower-middle-market businesses. While MRCC makes both debt and equity investments, lending is its primary focus.
Here’s the neat part: due to increasingly stringent regulations in the banking industry, traditional banks don’t usually lend to smaller businesses. As a result, lower-middle-market companies have to pay higher costs to get financing. And that has created an opportunity for specialty finance companies like Monroe Capital Corp.
As of September 30, 2018, the weighted average effective yield on Monroe Capital’s debt and preferred equity investments stood at 9.7%. (Source: “Monroe Capital Corporation BDC Announces Third Quarter Results,” Monroe Capital Corp, November 6, 2018.)
To put it simply, the company collects oversized interest payments from its portfolio, then passes them to shareholders in the form of dividends.
Managing Risks
And while high-yield debt may not seem like the safest investment vehicle, note that Monroe Capital Corp has been focusing on making senior secured loans.
In particular, I’m talking about first-lien loans.
You see, when a company wants to borrow money, it usually has to pledge its assets as collateral, so that—in the event that it defaults on the debt— the collateral will be liquidated to pay back the lender.
But if a company owes money to multiple lenders, who gets the money first in the event of liquidation? The first-lien lender.
That’s why investing in first-lien debt is one of the best things a BDC could do. The share of first-lien loans in Monroe Capital Corp’s portfolio by fair value has increased quite a bit over the past two years, from 77.7% at the end of September 2016 to 86.3% at the end of September 2018, helping the company improve its risk profile. (Source: “Company Overview,” Monroe Capital Corp, last accessed January 4, 2018.)
At the same time, Monroe Capital Corp’s portfolio is well diversified. By the end of the third quarter of 2018, the company had $482.3 million invested in 66 portfolio companies in more than 10 different industries. This ensures that, if something goes wrong at one of the portfolio companies, Monroe will likely still make enough money to meet its dividend obligation.
Speaking of MRCC stock’s dividend, let’s take a look at the company’s financials.
Covering a 14% Yield
As is the case for most BDCs, the key performance metric for Monroe Capital Corp is net investment income.
Excluding special items, the business generated adjusted net investment income of $0.38 per share in the third quarter of 2018. This was more than enough to support its quarterly dividend payment of $0.35 per share.
But what about previous reporting periods? Well, as it turns out, the company’s adjusted net investment income has covered its dividend for 18 straight quarters.
MRCC Stock: Trading at a Discount?
Last but certainly not least, the recent tumble in MRCC stock means it could offer good value for money. By the end of September 2018, Monroe Capital Corp had a net asset value of $12.95 per share. But today, the stock trades at just $10.00 apiece.
Therefore, if the company’s fundamentals haven’t changed much over the last three months, its current share price could represent more than a 20% discount to its net asset value.
Adding in a well-covered yield of 14%, MRCC stock could be an opportunity for dividend investors.