Ares Capital Corp. (ARCC:NASDAQ) (15.11, 10.1%) is a solid company, the largest of the dividend-paying BDCs. There have been some positive developments in the latest quarter: the Net Asset Value increased, modestly, again; there was improvement in the credit profile of its holdings; and it repurchased $5.5 million of its shares (though earlier in the quarter at lower prices).
The company continues to face headwinds, however. There is less deal activity in its segment throughout the industry, based on general credit and rate concerns. For Ares, its liquidity is fairly tight, meaning it will have to undertake some exits before doing significant new purchases. And its earnings fell shy, though just by 1 c, of its dividend. We should note though that Ares with 75% of its dividend covered by recurring income, has a good coverage profile.
The exit of GE Capital remains a burden
The major headwind however is the switchover from the wind-down of its old joint venture with GE Capital (which exited the credit business) to the new venture with an AIG affiliate. The latter is in the ramp-up stage with a long way to go to fully replace the GE venture. And in the short term, it could get worse; as Ares moves investments from its books to the joint venture, there will be an immediate decline in its earnings. However, this will free up cash on Ares' balance sheet and, over the longer term, leverage Ares' earnings power.
We are definitely holding Ares, and have no problem with new investors buying; again, it's top of its class and sports a very high yield. We are experiencing a period of undervaluation because of the GE Capital saga. However, we are not necessarily looking for any immediate appreciation, and could see weaker prices in the months ahead, so we would not add to positions right now.
Oil investments reduce NAV again
Gladstone Capital Corp. (GLAD:NASDAQ) (7.17, 11.7%) operates in a lower end of the market than Ares. It has stepped up investment over recent months, and has firepower to do new deals. Its pipeline has increased in recent months. Its Net Investment Income is covering the dividend.
The negatives for Gladstone recently have been another decline in the Net Asset Value, from both realized and unrealized losses. Its energy investments, representing about 16% of its portfolio, contributed to those losses, though, as we have mentioned before, these are three service companies, not directly related to the oil price, and all remain profitable.
I suspect the market wants to see several quarters of consistent dividend coverage, and new investments will help. Again, we are definitely holding and it's a buy for new investors, though we could see lower prices in the weeks ahead.
Dividend safe for now, but debt reduction ahead
Hutchison Port Holdings Trust (HPHT:Singapore) (US$0.425; 11.3%) is operating in a difficult environment right now. There is pressure on volumes, with exports from China generally soft, particularly to Europe, while the decline in the value of the renminbi has reduced revenue. Half of its contracts are up for renewal this year. While negotiations are still underway, the new tariffs will be backdated to the start of the year. In the current trade environment, there is likely to be some reductions in rates.
Looking ahead, Hutchison sees some pick up in volumes to the U.S., though remains cautious on Europe. It recently bought a major interest in an Egyptian port operator. Whether this is a strategic move to diversify or was purely opportunistic remains to be seen.
Hutchison has however taken a strategic decision to reduce leverage, aiming to cut debt by HK$1 billion per year for each of the five years beginning next year. This program will commence next year; this year's distribution is not affected.
At the current stock price—down from 50 cents two weeks ago—the yield is over 11%.
While we are cautious on global trade, and believe the company may need to reduce its dividend next year, we would continue to hold Hutchison, a well-run company, as part of a global income portfolio.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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1) The following companies mentioned in the article are sponsors/billboard advertisers/special situations clients of Streetwise Reports: Gladstone Capital. The companies mentioned in this article were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
2) Adrian Day: I or my family own shares of the following companies mentioned in this article: Ares Capital Corp., Gladstone Capital Corp. My company has a financial relationship with the following companies mentioned in this article: None. Clients of Adrian Day Asset Management hold shares of the following companies mentioned in this article: Ares Capital Corp., Gladstone Capital Corp., Hutchison Port Holdings Trust. I determined which companies would be included in this article based on my research and understanding of the sector. Statements and opinions expressed are the opinions of Adrian Day and not of Streetwise Reports or its officers. Adrian Day is wholly responsible for the validity of the statements. Streetwise Reports was not involved in any aspect of the article preparation or editing so the author could speak independently about the sector. Adrian Day was not paid by Streetwise Reports for this article. Streetwise Reports was not paid by the author to publish or syndicate this article.
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