Why SAR Stock Is Attractive Right Now
I’ve profiled a number of business development companies (BDCs) over the past few months. And for good reason. Rising interest rates are good for alternative banks like Saratoga Investment Corp (NYSE:SAR).
Rising interest rates are particularly good for BDCs that have a lot of floating-rate loans. On average, 80% of the loans in a typical BDC’s portfolio have floating rates. This means BDCs are positioned to generate a lot of money in today’s high-interest-rate environment.
On that front, Saratoga Investment does a little bit better than the average BDC: 99% of the loans in its portfolio have floating interest rates. Moreover, those interest rates are currently higher than all floors, and future increases are fully accretive to interest income. (Source: “Fiscal First Quarter 2024 Shareholder Presentation,” Saratoga Investment Corp, July 11, 2023.)
Saratoga Investment Corp is a BDC that specializes in providing loans to middle-market companies. It typically makes investments of $60.0 to $75.0 million in leveraged and management buyouts, recapitalizations, debt refinancing, growth financing, acquisition financing, and transitional financing. (Source: “Investment Profile,” Saratoga Investment Corp, last accessed August 28, 2023.)
Saratoga Investment typically lends capital to companies that have:
- Revenues in the range of $8.0 to $25.0 million
- Earnings before interest, taxes, depreciation, and amortization (EBITDA) of at least $2.0 million
- Large margins and high free cash flow
- Recurring revenues and stable historical performances
- Modest capital expenditures and working capital requirements
The companies also generally have leading market positions or niches with sustainable competitive advantages, strong management teams with meaningful stakes in the business, growth prospects in healthy end markets, and the ability to withstand business cycles.
The BDC has made investments in 42 distinct industries, including aerospace; automotive aftermarket and services; consumer products and services; education; financial services; food and beverage; health-care products and services; logistics and distribution; media and telecommunications; restaurants and food services; software and technology services; and specialty chemicals.
Saratoga Investment Corp’s loan portfolio includes first-lien, second-lien, mezzanine, and unitranche debt. According to the BDC, 96.5% of the credits in its portfolio “are the highest quality” and 85% of the investments are first lien. (Source: Saratoga Investment Corp, July 11, 2023, op. cit.)
The kinds of loans a BDC has in its portfolio are important. 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” investors usually receive only a fraction of their original investment back in the event of bankruptcy.
Saratoga Investment has reported a return on equity for the last 12 months of 7.2%, compared to the industry average of 1.5%.
Record Earnings in Fiscal First Quarter
For the first quarter of its fiscal 2024, ended May 31, 2023, Saratoga Investment announced that its assets under management increased by 21.2% year-over-year from $894.5 million to $1.1 billion and increased by 11.5% from $972.6 million in the fourth quarter of its fiscal 2023, ended February 28, 2023. (Source: “Saratoga Investment Corp. Announces Fiscal First Quarter 2024 Financial Results,” Saratoga Investment Corp, July 10, 2023.)
Its investment income, or portfolio income, grew in the first fiscal quarter by 85% year-over-year to $34.6 million. Its net investment income was $16.0 million, or $1.35 per share, up from $0.66 per share in the same quarter of last year. Its adjusted net investment income increased by 100.8% year-over-year to $12.8 million, or a record-high $1.08 per share.
Commenting on the results, Christian L. Oberbeck, Saratoga Investment Corp’s chairman, CEO, and president, said, “Higher and rising interest rates are producing increased margins on our portfolio, and the general contraction of available credit is creating an abundant flow of attractive investment opportunities from high quality sponsors at increasingly improving pricing, terms and absolute rates.” (Source: Ibid.)
He added, “With 85% of our investments at quarter-end in first lien debt and generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stressed situations, we believe our portfolio and leverage is well structured for future economic conditions and uncertainty.”
14th Quarter-Over-Quarter Dividend Increase in a Row
As a result of the company’s high earnings and continued stable credit performance, Saratoga Investment was able to increase its dividend for its fiscal 2024 second quarter to $0.71 per share. That’s up from $0.70 in the prior quarter and $0.54 in its fiscal 2023 second quarter. (Source: “Saratoga Investment Corp. Increases Quarterly Dividend by $0.01, or 1.4%, to $0.71 per Share for the Fiscal Second Quarter Ended August 31, 2023,” Saratoga Investment Corp, August 14, 2023.)
This worked out to a yield of 10.7%. Of note, this payout represents the BDC’s 14th consecutive quarterly dividend increase.
Oberbeck observed, “The impact of the absolute level and continued increase in interest rates on our largely floating rate assets, when combined with the growth of our overall portfolio, its resilient performance and our largely fixed rate liabilities, have resulted in record earnings.” (Source: Ibid.)
Saratoga Investment stock’s dividend isn’t the only thing that has gone up over the last number of quarters. In June, its share price hit a record high of $28.15. While it has given up a little ground since then, currently trading around $25.75, SAR stock is still up by 6.5% year-to-date and 19% year-over-year.
The outlook for Saratoga Investment stock is solid, with Wall Street analysts providing a 12-month share-price target in the range of $28.92 to $30.00. Even the low target would put SAR stock in record-high territory.
Chart courtesy of StockCharts.com
The Lowdown on Saratoga Investment Corp
Saratoga Investment is a great BDC with a growing, diverse portfolio. It has an attractive risk portfolio: 96.5% of its investments are of the highest quality, 85% are first-lien loans, and 99% have floating interest rates.
Because BDCs legally have to pay out at least 90% of their taxable income to investors, Saratoga Investment stock’s dividends are a big draw. From the second quarter of fiscal 2015 through the second quarter of fiscal 2023, Saratoga Investment Corp has increased its quarterly payout by 97.2% from $0.36 to $0.71.