BDC COMMON STOCKS

Week 42

Trifecta

There were three main data points announced this week regarding the U.S. economy – all of them “positive” – although not for the stock market.

Retail sales – non-inflation adjusted – increased by 0.7% in September and the previous number for August was also revised upward.

Manufacturing output – which was expected to increase by a tepid 0.1% last month – increased by 0.4%, despite strikes underway at several auto manufacturer locations.

Finally, “Goldman Sachs raised its gross domestic product growth estimate for the third quarter by three-tenths of a percentage point to a 4.0% annualized rate, which would be the fastest since the end of 2021”.

Reactive

This was too, too much for the bond market which pushed up yields to new record levels, especially in the intermediate and long-term maturities.

The 10-year Treasury yield exceeded 5% for the first time since 2007, ringing all sorts of bells on Wall Street.

Not helping the situation was that the Fed Chairman stated the obvious – that inflation is “still too high”, which suggested short-term interest rates are to remain at their currently high levels for some time longer.

Disappointed

The major stock market indices could not handle the news that their bond market competitors for investor dollars were performing so well.

The S&P 500 dropped (2.4%); the Dow Jones (1.6%) and the NASDAQ (2.9%).

The BDC sector – as measured by BDCZ and BIZD and the S&P BDC Index – followed suit – falling (1.7%) to (1.8%).

The more spectacular metric is that 40 of the public BDCS we track saw their price fall and only 2 were in the black.

To add insult to injury 11 BDCs fell more than (3.0%) in price over the 5 days ended October 20, 2023, including 4 that fell more than (5%).

Pretty Good

This was happening even as what news we were getting out of the BDCs in advance of the IIIQ 2023 earnings season was comforting, as discussed on these pages.

Golub Capital (GBDC) reported preliminary results for the IIIQ 2023 that included better-than-the-analysts-expected Net Investment Income Per Share (NIIPS) and Net Asset Value Per Share (NAVPS).

Main Street Capital (MAIN) seems to be headed for lower earnings this quarter than last – judging from its own preliminary IIIQ 2023 results – but NAVPS is also headed higher.

Of greatest interest to many shareholders, MAIN’s press release hinted at a generous “special” dividend to be announced for the IVQ 2023, which should top off a record payout year for this most popular of BDC players.

Our distributable net investment income in the third quarter exceeded the monthly dividends paid to our shareholders by over 45% and the total dividends paid to our shareholders by over 5%. Based upon the continued strength of our performance in the third quarter, we expect another meaningful supplemental dividend to be paid in the fourth quarter of 2023. This would represent our ninth consecutive quarterly supplemental dividend, to go with the six increases to our regular monthly dividends in the same time period

MAIN – Press Release – October 17, 2023

Moreover, as mentioned in prior editions of the Recap, the BDC analysts are busy increasing their earnings estimates for both the impending IIIQ and next year.

Plenty Of Runway

Based on the data we’re seeing – and the seeming certainty that the Fed will keep interest rates at a high level through most of 2024 – BDC peak earnings remain many quarters away.

If that’s correct, the sector will be able to boast – by the end of 2024 – of three consecutive years of EPS and dividend increases.

Very roughly, that would see BDC distributions increase by 25%-30% over their level in 2021, before interest rates took off.

Beyond

By the way, many observers are also coming to the conclusion that even when the Fed does begin to lower the base rate, there will be no going back to the days of ZIRP (Zero Interest Rate Policy).

The Fed Funds rate may well flatten out at a 2.5%-3.0% level if the economy continues to motor along.

Moreover, a strong economy is (almost) a guarantee against what BDCs fear most – an upsurge in credit losses that chisel away at earnings, book value, and shareholder confidence.

Deaf Ear

None of the above is factoring into this week’s BDC price action.

There is now only 1 BDC trading within 5% of its 52-week high, as opposed to 14 a few weeks ago (week ended September 22, 2023).

This suggests much profit-taking and market timing by investors.

There are 16 BDCs trading at 5%-10% of their top, and 10 trading within 10% of their 52-week lows.

Only 10 BDCs are trading above NAVPS versus 15 at our 2023 peak and a record of 21 back in 2021.

BDCZ is now trading only 3.2% above its price at year-end 2022.

A Theory

It’s possible that investors are looking beyond the stellar performance of the current economy and projecting just the opposite down the road in 2024 but that seems hard to believe after months and months of a BDC rally.

It’s possible the BDC sector will return to its winning ways once this spate of interest rate increases stabilizes, or turns downward.

Next week will see the beginning of a flood of BDC results released.

Question Mark

Both the analysts and the BDC Reporter are expecting – as discussed earlier – strong results across the board; a smattering of dividend increases and – going by BDC Best Ideas – a stable-to-increasing NAVPS trend.

Should that occur, will that be enough to revive BDC common stock prices, or are investors looking much further down the road whatever the next few weeks of earnings season brings?