This month’s correction has taken a toll on the high-yield universe, but it doesn’t change my long-term outlook for the majority of the dividend-payers I follow.
If I thought the market was going to roll over, I would tell my subscribers to bail out entirely, raise cash and look to re-enter the market on a decline of 20% – 30% for the S&P 500.
However, that’s not my view of the investment landscape…not with 70% of the first wave of companies meeting or beating Q3 estimates, over 200,000 jobs added per month, lending rates at the low of 2014, gasoline prices falling to around $3 per gallon and consumer sentiment reporting a three-year high last Friday.
Business development companies (BDCs) are not as well-known as other financial stocks — but they’re among the best-positioned groups to prosper in this market. After all, they’re able to borrow money at rates less than 2% and lend that money to private businesses at double-digit rates, which lets them maintain substantial cash flow from the loan portfolio.
With the dark clouds of market uncertainty starting to clear, here’s two of my favorite BDCs that are flashing a strong buy signal now.
Apollo Investment (AINV)
My first name for you today, Apollo Investment (AINV), is one of the biggest BDCs in the business, with a $2 billion market cap.
AINV is a prime example of a well-run business in light of the negative sentiment that’s dogged the larger financial sector for much of the year. In the second quarter, AINV reported 23 cents per share against a consensus estimate of 22 cents per share, and net asset value rose to $8.74 versus $8.67 at the end of the March quarter. Apollo invested $650 million during the quarter in secured debt deals while declaring a payout of 20 cents per share for the September dividend.
Shares of AINV are currently trading around $8 — so they are well off the $12 level seen in 2011. My price target is $10, and I believe that investors who buy Apollo Investment now can capture some significant capital gain in addition to the nice income paid each quarter along the way. With a forward yield of 10%, this BDC offers the kind of income potential that’s hard to pass up.
New Mountain Finance (NMFC)
New Mountain Finance (NMFC) is my most recent BDC pick, which I began following in late September after reviewing the recent set of financials and portfolio composition. Its extensive insider buying and solid 9.2% dividend yield make buying New Mountain a no-brainer.
As a small business development company focused on lending to “defensive growth” companies, New Mountain has demonstrated superior performance to its sector peers in the current year while flying under the radar of most high-yield investors. Looking at its fiscal Q2 results, net asset value came in at $762.6 million on a portfolio of 67 companies with a “weighted average Yield to Maturity at Cost of approximately 10.7%.”
Meanwhile, NMFC’s net investment income came in at 36 cents, two cents above analyst estimates, and revenues for 2014 are forecast to grow by 24% to $135 million, then by 19% in 2015 to $161 million …my kind of numbers. In addition, the potential for increased dividend payments is supported by a debt/equity ratio of 0.74x and a payout ratio of only 0.70x.
And, as noted above, insiders have been buying stock, accumulating over 3.4 million shares since November 2012, with not a single recorded sale during the same time period.
New Mountain will announce third-quarter earnings and declare its next dividend on Nov. 5. The recent volatility in high yield has NMFC shares trading nicely off their 52-week high of $15.50 and trading just above book value at around $14.85. In my view, the stock is attractively priced at current levels for a total return of 25% over the next 12 months, my price target being $17.
As with AINV, it’s a great time to invest in NMFC before the rest of the herd starts piling in.
Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with the goal of maintaining a blended total yield of 10% across two portfolios. And most recently, Bryan introduced Cash Machine Trader. With this service, he’s increasing the income stream potential even further by using covered call writing strategies to generate yield in the form of option premium — on top of capital appreciation income from well-known stocks.
