The Zacks SBIC & Commercial Finance industry is bearing the brunt of a low interest rate environment and subsequent rise in prepayments. These are likely to continue hurting the industry players’ profitability to some extent.
However, regulatory changes and robust economic growth are expected to aid the industry in the coming days. Stimulus packages have supported the firms in which these companies invest, thereby aiding credit quality. Hence, a few industry players like Main Street Capital Corporation (MAIN – Free Report) , Bain Capital Specialty Finance, Inc. (BCSF – Free Report) , and Newtek Business Services Corp. (NEWT – Free Report) are likely to benefit from these favorable developments.
About the Industry
The Zacks SBIC & Commercial Finance industry comprises companies that provide finance to small and mid-sized privately-held developing firms. These firms are typically underserved by traditional banks and other lenders. Additionally, firms suffering from financial distress are the primary target clients of these lenders. The industry players provide customized financing solutions ranging from senior-debt instruments to equity capital. This financing is provided for change of ownership transactions, strategic buyouts, recapitalizations, and growth initiatives in partnership with business owners, management teams as well as financial sponsors, among others. Some of the other products offered by the industry participants are mezzanine loans that typically pay high-interest rates and could be converted into equity in the target firm.
3 Key Factors Shaping the Future of SBIC & Commercial Finance Industry
Solid Asset Quality a Tailwind: Following the coronavirus outbreak and subsequent halt in business activities last year, the majority of sectors wherein SBIC & Commercial Finance companies provide loans were hit hard. This raised fears of a deterioration of asset quality for industry players. Yet, support from administration in the form of stimulus packages, extensive vaccination drive, and re-opening of businesses continue to support solid economic growth. Thus, these are likely to prevent a substantial rise in delinquency rates for the industry players.
Regulatory Changes Offer Support: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased the leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helped these companies to reduce portfolio risk by investing in higher capital structures without foregoing current returns. In other words, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Low Rates Weigh on Performance: The Federal Reserve slashed the interest rates to near-zero in March 2020 to support the U.S. economy from the COVID-19-induced slowdown. This has, thus, resulted in reduced total investment income, and is likely to keep hurting SBIC & Commercial Finance stocks’ top-line growth. A spike in prepayments and refinancing is also expected to hamper profitability to some extent. In fact, in the FOMC meeting earlier this month, the central bank signaled no hike in rates in the near term.
Zacks Industry Rank Indicates Bright Prospects
The Zacks SBIC & Commercial Finance industry is a 34-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #101, which places it at the top 40% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of encouraging earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s bottom-line growth potential. Over the past year, the industry’s earnings estimates for the current year have been revised 12.8% upward.
Therefore, we are presenting a few stocks that are well-positioned to outperform the market based on a strong earnings outlook. Before that, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Outperforms Sector and S&P 500
The Zacks SBIC & Commercial Finance industry has outperformed both the S&P 500 composite and its own sector over the past year.
While the stocks in this industry have collectively gained 35.4% over this period, the Zacks S&P 500 composite and Zacks Finance sector have rallied 32.5% and 31.4%, respectively.
One-Year Price Performance
Industry’s Current Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing loan providers because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.88X. A highest level of 1.10X, lowest of 0.41X, and a median of 0.96X have been recorded by the industry over the past five years. Also, the industry is trading at a significant discount compared with the market at large, as is evident from the trailing 12-month P/TB for the S&P 500 composite of 17.31X, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a low P/TB ratio, comparing SBIC & commercial loan providers with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TB of 4.20X is way above the Zacks SBIC & Commercial Finance industry’s ratio, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
3 SBIC & Commercial Finance Stocks to Invest in
Main Street Capital: This Zacks Rank #2 (Buy) private equity firm specializes in providing equity capital to lower middle-market (LMM) companies. Main Street Capital also offers debt capital to middle-market companies. Based in Houston, TX, MAIN invests in lower middle market companies that generate annual revenues between $10 million and $150 million.
As of Sep 30, 2021, Main Street Capital had total investments (fair value) of $2.76 billion, which consisted of investments in LMM portfolio, middle-market portfolio, and private loan portfolio. As of the same date, MAIN’s net asset value (NAV) was $24.27 per share.
At the end of the September quarter, Main Street Capital had total liquidity of $714.6 million, which included $59.6 million in cash and cash equivalents, and $655.0 million of unused capacity under its revolving credit facility. As of Sep 30, 2021, MAIN had total debt worth $1.27 billion consisting of debentures and senior notes.
Since its October 2007 initial public offering, Main Street Capital has regularly raised its monthly dividends. In sync with this, earlier this month, MAIN announced monthly cash dividend of 21.5 cents per share for January, February, and March 2022 each, aggregating to 64.5 cents per share to be paid in the first quarter of 2022. This represents a 2.4% hike from the monthly dividends paid for the fourth quarter of 2021 and a 4.9% rise from the monthly dividends paid for the first quarter of 2021.
Main Street Capital has a market cap of $3.2 billion. So far this year, MAIN stock has gained 42.7%. The Zacks Consensus Estimate for earnings has been revised 4.9% upward to $2.57 for 2021 and 2.7% north to $2.62 for 2022 over the past 30 days.
Price and Consensus: MAIN
Bain Capital: Headquartered in Boston, MA, Bain Capital is a specialty finance company that primarily invests in middle-market companies (firms having annual earnings before interest, taxes, depreciation and amortization in the range of $10-$150 million). This Zacks Rank #2 company is managed by BCSF Advisors, LP, an SEC-registered investment adviser and a subsidiary of Bain Capital Credit, LP.
As of Sep 30, 2021, Bain Capital had total investments (fair value) of $2.4 billion, which consisted of investments in 105 portfolio companies operating in 29 industries. As of the same date, BCSF’s asset coverage was 181% and NAV was $17.03 per share.
For the nine months ended Sep 30, 2021, Bain Capital had invested $891.3 million, including Payment-in-kind (PIK), in 63 portfolio companies. Moreover, BCSF had total debt worth $1.36 billion as of Sep 30, 2021, with no maturities till 2022-end.
Shares of Bain Capital, which has a market cap of $996.8 billion, have rallied 27.2% in the year-to-date period. The Zacks Consensus Estimate for 2021 earnings has remained unchanged at $1.36 while for 2022 it has been revised nearly 1% upward to $1.38 over the past 30 days.
Newtek Business: Headquartered in Boca Raton, FL, the company provides a wide range of business and financial solutions to the small-and-medium sized business market under the Newtek brand.
As of Sep 30, 2021, Newtek Business had total investments (fair value) worth $712.5 million and NAV of $16.23 per share. Also, NEWT projects 2021 net investment income (NII) to be 80 cents per share and adjusted NII to be $3.40 per share.
In March 2021, the company revealed plans to announce dividend in the range of $3.00-$3.30 per share this year. Newtek Business has already paid out dividend of $2.10 per share in the first three quarters of 2021.
Also, NEWT has announced a fourth-quarter cash dividend of $1.05 per share, which will be paid on Dec 30. With the payment of the fourth quarter dividend, the company will have paid $3.15 per share in dividends in 2021, marking a 53.7% jump over dividends paid last year. Thus, this makes Newtek Business stock an attractive pick for investors.
In August, Newtek Business inked a deal to acquire National Bank of New York City, a nationally chartered bank. The acquisition is part of a plan to reposition NEWT as a bank holding company, and is still subject to certain regulatory and shareholder approvals.
Newtek Business has a market cap of $686.7 million. Shares of this Zacks Rank #1 company have surged 54.5% so far this year. The Zacks Consensus Estimate for 2021 earnings has moved 1.8% north to $3.42 over the past 30 days. Likewise, the same for 2022 has been revised 21.1% upward to $2.81 over the past month.
Price and Consensus: NEWT