Does Ares Capital Still Deserve an “A” Grade?

Ladies and gentlemen, I am happy to announce that it’s that time of year again!

That’s right. It’s time to play one of our favorite games here at Safety Net…

Is Ares Capital’s Dividend Still Safe?

Ares Capital (Nasdaq: ARCC) is a business development company (BDC) that Chief Income Strategist Marc Lichtenfeld has reviewed in each of the past two years – first in March 2022 and again last August.

At this point, I say we make it a tradition to review Ares yearly, as it’s one of our most popular requests – and it seems to be the gift that keeps on giving.

In 2022, the stock had an attractive yield of 8.7%, and Marc gave it a “B” for dividend safety. In 2023, the yield reached double digits, and he bumped his grade up to an “A.”

Ares currently pays a quarterly dividend of $0.48, which comes out to a very nice 9.3% annual yield. Let’s see whether it still deserves that lofty “A” grade this year.

Before we dig into the numbers, though, it’s important to remember that when we evaluate BDCs, our parameters are slightly different from the ones we use for normal stocks.

The biggest difference is that we look at net investment income (NII) instead of free cash flow.

Net investment income is the amount of money a company makes from its investments, while free cash flow is the amount of money a company has left over after paying its expenses.

We use NII for BDCs because they are purely in the business of investing in other companies, so we need to know whether their investments are actually paying off and growing.

The second major difference is that when we evaluate a BDC, our threshold for the company’s payout ratio is 100% instead of the usual 75%. We give BDCs this extra leeway because they, like real estate investment trusts (REITs), are required to pay out 90% of their income to investors.

Now that we’ve established those differences, let’s see how Ares Capital stacks up.

Our first step is to look at the company’s NII.

And I must say, it’s looking pretty good.

From 2020 to last year, Ares saw 60% growth in its NII.

And Wall Street analysts expect NII to jump from $1.27 billion last year to $1.45 billion this year, an additional 16.5% increase.

So clearly, the company’s cash flow growth is strong…

But we still must consider the all-important payout ratio and the actual dividends paid out to investors.

In 2023, the company paid out $1.03 billion in dividends for a payout ratio of 81.1%, and the payout ratio is expected to drop to 75.9% this year.

As I said earlier, it’s fine for a BDC’s payout ratio to be above 75% as long as it’s still below 100%. Ares is comfortably below that level.

On top of that, the company hasn’t made any cuts to its regular dividend since 2009.

So, with all of this in mind, I am happy to say that Ares’ dividend is still as healthy as it was last year.

Dividend Safety Rating: A

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