Updated on February 27th, 2020 by Josh Arnold
Business Development Companies, or BDCs, have become popular among income investors. That is because BDCs, as an alternative asset class, offer very high dividend yields, thanks in part to a favorable tax structure. The companies generally achieve extremely high yields on their investments, which they pass along to shareholders in the form of distributions.
For example, Solar Senior Capital (SUNS) has a current dividend yield of 8.1%. You can see the full list of high-yield dividend stocks by clicking here.
Not only does Solar Senior have a very high yield more than four times that of the broader market, it also pays its dividend each month, rather than once per quarter. This allows investors even faster compounding, and more current income.
Solar Senior is one of fewer than 60 monthly dividend stocks.
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:
Solar Senior offers a very high level of income, and a way for investors to gain exposure to privately-held companies with the potential for growth. The company certainly is not without risks, but for those investors that can stomach a bit of uncertainty, Solar Senior’s yield may be worth it. This is particularly true as yields on other income investments continue to move lower.
Business Development Companies make debt or equity investments in companies that have not yet gone public, which are typically at an earlier stage of development and require growth financing.
They offer a way for people to invest in private companies without having to gain accredited-investor status. In addition, BDC’s generally have widely diversified portfolios, offering investors the protection of diversification by simply owning the BDC rather than many smaller investments.
Solar Senior Capital is a value-oriented investment company. It invests predominantly in senior secured debt of privately-held middle market companies that broadly fit the characteristics below.
Source: Investor Relations
The company targets investments in entities with revenues of at least $50 million and EBITDA of at least $15 million, offering a measure of safety, as companies with these characteristics are sizable and profitable. Companies that meet these needs are generally well established and therefore offer less risk during a downturn, for instance.
Solar Senior generally invests $5 to $20 million of its capital in each position, meaning its portfolio is never too concentrated on one or a handful of positions. This helps the company diversify away its risk from portfolio concentration.
Source: Investor Relations
As of the end of 2019, Solar Senior had a $665 million investment portfolio, up significantly from the year-end 2018 level of $534 million. Out of the $665 million, 97% is in floating rate instruments, which is also up from 92% at the end of 2018. Solar Senior has clearly positioned its portfolio for rising interest rates with its almost full position in floating rate instruments.
The portfolio’s total yield is also very attractive at 9.7%, although that is down slightly year-over-year when it crested 10%. About half of the portfolio, which is based on cash flow first lien senior secured loans, yields just over 7%, while some higher-risk bets make up the remainder of the loan book, and boost the average yield. We note again the company has repositioned itself in the last year for higher rates.
This sort of portfolio yield is very attractive and helps Solar Senior pay its large distribution.
Source: Investor Relations
Solar Senior’s diversification and scale can be seen here as the company is invested in 227 different entities across 125 industries. This diversification provides protection against economic weakness in particular sectors and against shocks from potential weakness from a single customer or group of customers.
Solar Senior has grown its portfolio in the past year by investing in more unique entities, as well as more unique industries, further increasing its diversification.
One of the ways Solar Senior can generate growth is through new investment. The company has a sizable amount of capital left on the balance sheet.
Solar Senior ended 2019 with about $100 million of available capital, subject to its borrowing base limitations. This is down from more than $200 million at year-end 2018, but as mentioned, the company has significantly grown its portfolio in the past twelve months.
The growth prospects for Solar Senior are reliant upon the health of its investment portfolio. Should its investments perform well, Solar Senior will report higher levels of net investment income, which then translates into higher shareholder dividends.
Full-year 2019 results were essentially flat with 2018 results, which is consistent with how the company has performed in recent years. Net investment income was $1.41 per share in 2019, the same value as 2017 and 2018, and fractionally lower than in 2016. Growth has been challenging to come by for Solar Senior on a per-share basis.
Net asset value ended the year at $16.32 per share, which is essentially flat with the 2018 year-end value of $16.30, and is a modest discount to the current share price of $17.40. As a result of the stock’s premium to net asset value, we don’t see valuation expansion as a significant source of returns for shareholders in the coming years. Instead, we see a potential headwind from the valuation.
As mentioned, Solar Senior spent 2019 growing its portfolio as it has positioned itself for rates to eventually move higher. New originations totaled $258 million in 2019, while repayments were $186 million, for net portfolio activity of ~$72 million.
Management remains committed to paying the distribution, as a cut in the payout would likely result in a significantly lower valuation for the stock. We do not expect much dividend growth from Solar Senior going forward.
BDCs are considered pass-through securities, which means they are generally not taxed at the company level. This allows them to make high levels of distributions to investors, which results in their hefty dividend yields. Shareholders are taxed on distributions, although one of the advantages of BDCs is that investors do not have to deal with the K-1 form each year. Instead, they are required to submit a 1099-DIV.
Solar Senior continues to pay a monthly distribution of $.1175 per unit, which it has done since September of 2012. This comes out to an annualized distribution of $1.41 per unit. While the lack of dividend increases may be off putting to some investors, the distribution hasn’t been cut or suspended, and the yield is still quite robust.
Based on Solar Senior’s recent unit price of ~$17.40, the stock has a yield of 8.1%. Solar Senior is not an attractive choice for dividend growth investors, given its flat distributions for many years. However, it offers a very hefty yield, more than four times the average dividend yield in the S&P 500 Index.
In addition, given that net investment income fully covers the dividend, albeit only barely, the yield appears to be sustainable. If there is a significant downturn in the performance of the company’s portfolio, the yield would almost certainly be at risk.
However, dividend coverage has been near 100% for years and there hasn’t been a cut, so we remain relatively optimistic. Investors should also keep in mind that BDCs often issue new shares to cover dividend shortfalls, and Solar Senior could go that route if it is slightly short of covering its dividend.
Solar Senior’s distribution coverage is very tight right now, but that has been the case for many years. As a BDC, it will always pay out most or all of its income to shareholders, so coverage will likely never be low. With portfolio growth should come additional net investment income, which should, in turn, offer better dividend coverage.
However, Solar Senior has reduced its overall portfolio yield in the past year by positioning for higher rates. Should rates remain very low, or move even lower, the dividend could be at risk.
The company has invested for future growth, although shareholders have yet to reap rewards from those investments, and future growth is now more dependent than ever on rates moving up.
Investors interested in high-yielding BDCs could find Solar Senior to be an attractive stock. While this is not an appropriate investment for those seeking dividend growth, the 8%+ yield is appealing for those strictly seeking high levels of income right now. Investors would do well to understand the risks of the company’s floating-rate portfolio, but if rates move in a favorable direction for Solar Senior, the rewards could be significant.