BMO Capital Markets analyst Lana Chan upgraded Ares Capital Corp. to "outperform" from "market perform," saying it has a best-in-class business development company model and has no execution risk related to transitioning out of legacy businesses or asset cleanups. As a result, Chan raised the company's price target to $20 from $19.
Chan wrote that a key feature of Ares Capital's business model is its ability to generate returns even during an economic downturn, citing the company's success in restructuring troubled loans to profitable equity-component investments and deploying capital into loans with "very attractive spreads" during the financial crisis.
The analyst wrote that BDCs are attractive for investors in an environment of low interest rates and benign credit. Chan said Ares Capital's 8.6% dividend yield is attractive in the context of a low 10-year U.S. Treasury yield and $16 trillion of bonds worldwide trading with negative yields. While BDCs tend to be sensitive to interest rate changes, Chan said the company has "a number of levers" to sustain the dividend in the medium term, including the ability to increase leverage by 2x thanks to a lower asset coverage requirement and roughly $325 million in excess taxable income, which it can deploy any quarter it does not cover its dividend fully.
Finally, Chan wrote that the company's existing non-accruals have been largely written down and that management has enhanced its portfolio monitoring amid ongoing trade tensions. The analyst also said she expects credit quality in the industry to remain benign as banks continue to ease commercial and industrial standards, according to a July Senior Loan Officer Survey.
