Investing

Business Development Companies in Solid Shape: 3 Stocks to Buy

Sanghamitra Saha

Published: July 29, 2023 5:27 am

Business Development Companies (BDCs) are firms that give loans to small and mid-sized companies at relatively higher rates and often grab debt or equity stakes in those. BDCs dole out high and stable cash distribution while captivating the equity performance of the borrower.

U.S. law obliges BDCs to distribute more than 90% of their annual taxable income to shareholders. Against this backdrop, top-ranked stocks Saratoga Investment Corp SAR, Crescent Capital BDC CCAP and Main Street Capital MAIN emerge as strong picks.

Inside July’s Fed Rate Hike

Notably, the Fed raised its benchmark interest rate by 0.25% on Wednesday, leaving room for more hikes this year. Short-term rates are now in the 5.25-5.50% range, the highest since March 2001. This marked the 11th increase since March 2022, and the Fed stated that future hikes would depend on the economy and financial developments. The decision was unanimous.

“The process of getting inflation back down to 2% has a long way to go,” Fed Chair Powell said in a press conference Wednesday, as quoted on Yahoo. Powell added that bringing down inflation “is likely to require a period of below-trend growth and some softening of labor market conditions.”

How Is the Operating Environment for Business Development Firms?

With the Fed continuing to hike rates and the regional banks coming under a tight spot, small-sized firms have every reason to turn to business development companies to arrange for funding. Although second-quarter corporate transaction activities like M&A remain slower than recent history, it has gained momentum compared to the first quarter.

Direct lenders gain a significant share as 85% of new issue LBO financing in the United States was completed by direct lenders. Direct lending also continues to be increasingly active beyond the arena of the LBO market as direct lenders accomplished 1.5X as non-buyout financings as the broadly syndicated market during the second quarter, according to data by LCD, as quoted on the earnings transcript of Ares Capital ARCC.

Despite companies coping with higher borrowing costs, credit quality has been stable, and inflation too has started cooling. In a rising rate environment, these companies can potentially generate higher interest income on their loan portfolios, which could boost their overall revenues.

BDCs can actively manage their portfolios to adapt to changing interest rate conditions. They might adjust the duration and composition of their investments to optimize their returns. Some BDCs may choose to diversify their investment strategies to include floating-rate loans or other assets that can benefit from rising interest rates.

Our Picks

Against this backdrop, below we highlight a few business development stocks that could be strong picks right now.

Saratoga Investment Corp SAR

The Zacks Rank #1 (Strong Buy) specialty finance company invests primarily in leveraged loans and mezzanine debt issued by U.S. middle-market companies, both through direct lending and participation in loan syndicates. The company has been elected to be treated as a business development company.

The company’s expected earnings and revenue growth for the upcoming quarter is 75.86% and 61.99%, respectively. The stock has surpassed earnings estimates in each of the past four quarters, with an average surprise of 16.39%.

Crescent Capital BDC CCAP

The business development company focuses on originating and investing in the debt of private middle-market companies. CCAP currently carries a Zacks Rank #2 (Buy).

The company’s expected earnings and revenue growth for the upcoming quarter is 31.71% and 70.75%, respectively. The stock has surpassed earnings estimates in two of the past four quarters, while missed in the other two. It has delivered an average surprise of 5.39%.

Main Street Capital MAIN

The Zacks Rank #2 specialty investment company provides customized financing solutions to lower middle-market companies that operate in diverse industry sectors. Main Street seeks to partner with entrepreneurs, business owners and management teams, and generally provides one-stop financing alternatives to its portfolio companies.

The company’s expected earnings and revenue growth for the upcoming quarter is 32.0% and 40.9%, respectively. The stock has surpassed earnings estimates in three of the past four quarters, and reported in line in the other. This led to an average surprise of 7.29%.

Ares Capital Corporation (ARCC): Free Stock Analysis Report

Main Street Capital Corporation (MAIN): Free Stock Analysis Report

Saratoga Investment Corp (SAR): Free Stock Analysis Report

VanEck BDC Income ETF (BIZD): ETF Research Reports

ETRACS MarketVector Business D (BDCZ): ETF Research Reports

Crescent Capital BDC, Inc. (CCAP): Free Stock Analysis Report

ETRACS Quarterly Pay 1.5x Leve (BDCX): ETF Research Reports

To read this article on Zacks.com click here.