Updated on May 21st, 2021 by Bob Ciura
Business Development Companies – or BDCs, for short – can be a great source of current yield for income investors.
Main Street Capital Corporation (MAIN) is a great example of this. This BDC has a current dividend yield of 6%. Better yet, Main Street Capital Corporation pays monthly dividends.
You can download our full Excel spreadsheet of all monthly dividend stocks (along with metrics that matter like dividend yield and payout ratio) by clicking on the link below:
The stock’s high dividend yield and monthly payments make it a solid choice for income investors. But what about the strength of the underlying business?
Fortunately for investors, Main Street Capital’s business appears to be performing well. This article will discuss the investment prospects of Main Street Capital Corporation in detail.
Main Street Capital Corporation is a Business Development Company, or BDC. You can see our full BDC list here.
The company operates as a debt and equity investor for lower middle market companies (those with $10-$150 million of annual revenues) seeking to transform their capital structures. The BDC has the capability to invest in both debt and equity, which gives it a significant advantage over companies who invest in private debt or private equity alone.
Main Street Capital Corporation also invests in the private debt of middle market companies (not lower middle market companies) and has a budding asset management advisory business.
Source: Investor Presentation
The BDC’s corporate structure is rather simple. Main Street Capital Corporation operates three funds:
- The Main Street Mezzanine Fund
- The Main Street Capital II Fund
- The Main Street Capital III Fund
Since Main Street Capital Corporation is the operator of its own investment funds, management fees are kept to a minimum, which gives it a cost-based competitive advantage over its competitors who outsource their fund management.
Main Street Capital Corporation’s holdings are highly diversified by both transaction type and geography. By transaction type, the BDC acquires most of its deals via recapitalization and leveraged buyouts. Main Street Capital Corporation also has a very high degree of diversification by industry.
Main Street Capital Corporation’s growth prospects come from its unique strategy to driving investment returns. Investors who own the stock are rewarded as the BDC sustains its high monthly dividend and grows it over time.
At the business level, Main Street Capital Corporation’s growth will be driven by its expertise in the lower middle market segment of the economy.
On May 6th, Main Street Capital released first-quarter results. Net investment income of $39.8 million was a 9% increase compared to $36.5 million a year ago. The corporation generated net investment income per share of $0.58, up 2% from last year’s income of $0.57. Distributable net investment income per share totaled $0.62, up 2% from $0.61 in the first quarter of 2020.
Main Street’s net asset value per share increased compared to the end of 2020, from $22.35 to $22.65. The corporation declared monthly dividends of $0.205, representing an annual dividend of $2.46 per share. As of the end of first quarter 2021, the corporation had aggregate liquidity of $818 million, consisting of $65 million in cash and cash equivalents, $693 million of unused capacity under the revolving credit facility, and $60 million remaining in the Small Business Investment Company debenture capacity.
To conclude, Main Street Capital Corporation has expertise in the lower middle market of its industry and has a budding asset management business that enables it to have strong operational leverage. These factors will drive the BDC’s growth for the foreseeable future.
Competitive Advantages & Recession Resiliency
As an investment manager, Main Street Capital Corporation’s main competitive advantage comes from the talent it employs to source and fund deals.
The company’s senior management team has been largely unchanged since inception. The company’s CEO, Vince Foster, has been in place since the 2007 IPO and worked for the predecessor of Main Street Capital Corporation previously.
A similar level of longevity is seen across Main Street’s senior executive team. Main Street Capital Corporation also has a cost-based competitive advantage. As an internally-managed private investor, Main Street generates substantially lower operating expenses than its externally-managed counterparts, which helps improve net income.
As mentioned, Main Street Capital Corporation also has a durable competitive advantage due to its unique expertise in the lower middle market private debt & equity segment. This segment is generally too small for commercial banks to lend to, but too large for the small business representatives of retail banks to lend to.
Finance companies and asset managers are often vulnerable to recessions since investors are likely to pull their money to cut losses when financial markets are in distress. With that said, Main Street invests in private deals and lacks the same type of liquidity as, say, a mutual fund. Thus, Main Street Capital Corporation is expected to be moderately recession-resilient.
Although Main Street Capital Corporation came public shortly before the last recession, the company performed well during this difficult operational period:
- Net-investment-income-per-share 2007 – $0.76
- Net-investment-income-per-share 2008 – $1.15 (51% increase)
- Net-investment-income-per-share 2009 – $0.92 (20% decrease)
- Net-investment-income-per-share 2010 – $1.16 (26% increase)
- Net-investment-income-per-share 2011 – $1.69 (46% increase)
- Net-investment-income-per-share 2012 – $2.01 (19% increase)
The company’s financial results were also impressive from the perspective of distributable net income:
- Distributable-net-investment-income 2007 – $1.10
- Distributable-net-investment-income 2008 – $1.44 (31% increase)
- Distributable-net-investment-income 2009 – $1.50 (4% increase)
- Distributable-net-investment-income 2010 – $1.50 (no change)
- Distributable-net-investment-income 2011 – $1.56 (4% increase)
- Distributable-net-investment-income 2012 – $1.71 (10% increase)
While Net-investment-income-per-share declined from 2008 to 2009, Main Street Capital returned to growth the following year. All said, Main Street Capital Corporation appears fairly recession-resistant.
Valuation & Expected Returns
Conservatively, we expect net investment income to grow at 2% annually through 2026. Over the past decade, Main Street Capital has traded with an average price-to-net-investment-income ratio of 15. Based off of the current share price and expected net-investment income of $2.35 per share for 2021, the stock has a P/NII ratio of 17.5.
Our fair value estimate for Main Street stock is a P/NII ratio of 14.8. Therefore, a declining valuation multiple could reduce annual returns by 3.3% over the next five years.
The high dividend yield is expected to account for the bulk of Main Street’s total returns, with a smaller contribution from NII-per-share growth.
Source: Investor Presentation
Expected total annual returns are as follow:
- 6% dividend yield (includes supplemental dividends)
- 2% net-investment-income growth
- -3.3% valuation multiple reduction
We expect that shares of Main Street Capital can offer a total annual return of 4.7% through 2026. This is a decent, although unspectacular, expected rate of return for Main Street stock.
Although Main Street Capital Corporation is off-the-radar for most dividend growth investors, this BDC has a strong history of delivering substantial shareholder returns.
The firm’s strong track record of superior investment management and expertise in the lower middle market segment give it a strong competitive advantage in the private equity and debt industry.
Further, Main Street Capital Corporation is shareholder-friendly with a high yield and monthly payouts. The stock’s high yield and monthly dividend payments might be suitable for income investors, although the modest expected rate of return keeps the stock as a hold recommendation right now.