Business development companies, BDCs, provide high-yield access to private and venture capital-backed companies, a part of the market otherwise inaccessible to most retail investors.

Houston-based Main Street Capital Corporation (MAIN) is a BDC internally managed, which specializes in equity for lower-middle-market companies – LMMs, with revenue between $10 million and $150 million and EBITDA between $3 million and $20 million. It was founded in 2007. It is one of the largest BDCs, with a market cap of $3.1 billion and over $5 billion in assets under management.

MAIN’s total investment portfolio at fair value consists of approximately 48% lower middle market, 32% private loans, 11% middle market and 9% other portfolio investments.

MAIN owns 184 lower middle market, private lending and middle market portfolio companies with an average investment size of $16.6 million. Its largest individual holding company represents 3.4% of MAIN’s total investment income and 2.5% of the total fair value of the portfolio (most investments are less than 1%). The weighted average effective yield of the portfolio is 9.3%.

As of 12/31/21, MAIN held 9 unearned investments, which represent 0.7% of the total investment portfolio at fair value and 3.3% at cost.

Lower Middle Market Portfolio

MAIN’s LMM holdings are in 73 portfolio companies, worth $1.72 billion in fair value. 99% of these bond investments have 1st lien positions, while 59% of them earn fixed rate interest. There is a net cash interest margin of approximately 800 basis points over the “matching” fixed interest rate on the SBIC debentures.

Equity investments: MAIN owns shares in 100% of the companies in its LMM portfolio, representing an average ownership position of 40%, which provides an opportunity for fair value appreciation, which in turn supports the growth of NAV/share value of MAIN, in addition to capital gains and cash dividends. Income. 59% of these LMM companies with direct equity participation currently pay dividends to MAIN.

The average investment size is $23.5 million. These companies have average principal leverage of 2.5X EBITDA thanks to MAIN’s debt position, with higher interest coverage of 2.6X EBITDA and total leverage of 2.8X EBITDA .

The LMM portfolio is spread across many sectors, including machinery, construction and engineering, professional services, and energy equipment and services, accounting for 32%.

Private loan investment portfolio

This portfolio is made up of 75 investments, with a valuation of $1.14 billion, representing 32% of MAIN’s total investment portfolio at fair value. The average investment size is $15.4 million (less than 1% of the total portfolio).

95% of MAIN’s private loan portfolio is secured debt, 99% of which is senior debt. 96% of these loans bear interest at variable rates, with a net cash interest margin of 550 basis points over the “matched” variable rate on MAIN’s credit facility.

Middle Market Investment Portfolio

This portfolio consists of 36 investments, with a value of $395 million, representing 11% of MAIN’s total portfolio at fair value. The average investment size is $12.2 million, or less than 1% of the total portfolio. 93% of this middle market portfolio is secured debt, 99% of which is senior.

96% of these debt investments bear interest at variable rates, with an overall average of 7.5%, as of 12/31/21. There is a net cash interest margin of 475 basis points over the “matched” variable rate on the MAIN credit facility.

Earnings

MAIN had another strong quarter in Q4 2021, with Total Investment Income up 31.5%, NII up 29%, DNII up 28%, NII/Share up 23.7% and NAV/Share up 13% to $25.29 from $22.35 in Q4 ’20.

This capped a year of very strong growth for the whole of 2021, which saw total investment income increase by 30%, NII by 32%, DNII by 40% and NII/Share by 26%. Realized gains reversed to $45 million from a loss of -$116 million in 2020, as did unrealized appreciation which turned to $135.62 million from a loss of – $5.6 million in 2020.

new business

During the fourth quarter of 2021, management made $316.3 million in total investments in the lower middle market portfolio, including investments totaling $225 million in 6 new LMM portfolio companies, which after global debt principal repayments and the return of invested equity from several LMM portfolio investments, resulted in a net increase of $209.7 million in total investments in the LMM portfolio.

They also made $380.4 million in total investments in the private loan portfolio, with a net increase of $290.4 million. There was a net decrease of $16.4 million in middle market portfolio investment during the quarter.

Looking back further shows the decline in DNII caused by the pandemic in 2020. However, MAIN’s DNII rebounded considerably in 2021, increasing by more than 15% compared to the pre-pandemic figure in 2019:

Dividends

At its 3/3/22 closing price of $43.39, MAIN was down 5.95%. Management announces the 3 monthly dividends for the next quarter in advance during the previous quarter. They usually go ex-dividend at the beginning of the month, while paying out in the middle of the following month.

MAIN has a 5-year dividend growth rate of 1.58%. However, management increased the monthly payment from $0.21 to $0.215 in Q1 22. MAIN will also pay a special dividend of $0.075/share in March, with an ex-dividend date of 3/21/22.

Another metric that rebounded in 2021 was MAIN’s dividend coverage. DNII/Dividend coverage reached 1.22X in Q4 21, with an average of 1.13X for 2021, compared to only 0.95X for the whole of 2020.

NII coverage was 1.16X in Q4 2021 and averaged 1.06 for 2021, compared to 0.85X in 2020.

MAIN has a long history of building shareholder value – Cumulative dividends paid or declared, including incremental dividends, since MAIN’s IPO in October 2007, at $15.00/share, through Q2 2022 equaled $33.54/share.

MAIN had $260.7 million, or $3.69/share, of pre-tax unrealized net appreciation as of December 31, 2021.

Profitability and leverage

ROA remained stable in 2021, while ROE improved by 110 bps and EBIT/interest coverage improved to 4.1X, from 3.78X in 2020. Management slightly increased the leverage, from 0.8X to 1X, but MAIN’s leverage is still more conservative than BDC’s industry average of 1.13X.

However, on 2/28/22, MAIN management announced that it had received approval from the MAIN Board of Directors to reduce the minimum asset coverage ratio from 200% to 150%, which should bode well. for future growth. In BDC-Land, higher levels of debt are used to create more revenue – the trick is that management is not overloaded with leverage.

Debt

MAIN has an investment grade rating of BBB-/Stable from S&P.

Its next debt maturity is $185 million – its 4.5% senior bonds, which mature on 12/1/2022 and are callable at any time. 2023 has no significant maturities, while 2024 has $513.8 million coming in 5.2% bonds and SBIC debentures:

Ratings

As you may have noticed in our items About BDC, we maintain a database of BDC valuations, leverage and profitability.

At $43.39, MAIN earns a premium valuation of 71.57% over its 12/31/21 NAV/share of $25.29. This premium valuation is not a recent phenomenon – as an industry leader, MAIN has a history of higher valuations than most other BDCs.

The only time its P/Book fell below 1X in the last 5 years was during the COVID Crash in 2020. This panic created a golden opportunity for income investors to buy MAIN with a rare discount. Based on this chart, an investor who bought MAIN between 1.2X and ~1.3XP/Pound over the past 5 years would have done well:

MAIN’s 71.5% premium to NAV per share is much higher than BDC’s average valuation of 15% above NAV, while its price/NII per share, price /sales and its EV/EBIT are also higher. It yields 5.95%, compared to the BDC average of 8.21%.

Of course, there’s some “get what you pay for” thinking here – BDC’s industry averages include companies that have been sketchy at best, with eroding earnings and negative dividend growth.

Performance

MAIN has outperformed the BDC industry, the broader financial sector and the market over the past year, but has lagged so far in 2022, although it has held up slightly better than the S&P over the past month and quarter.

All charts by Hidden Dividend Stocks Plus, except where noted.