Main Street Capital (NYSE: MAIN) is one of the most consistent dividend payers in the business development industry, in my opinion.
The company pays a monthly dividend of $0.22 per share and supplements it with special dividends to distribute excess earnings. Having That said, I don’t believe Main Street’s valuation is entirely justified.
BDC stock trades at a 69% premium to net asset value, the highest premium in the BDC industry.
Despite the fact that the dividend is attractive and covered by net investment income, investors are likely to pay more for the BDC’s income stream.
Good NAV growth, safe portfolio and low payout ratio
Over the past fifteen years, Main Street has made a name for itself by delivering consistent portfolio results, particularly in terms of net asset value growth.
Main Street’s net asset value fell during the Covid-19 pandemic as asset values fell and some borrowers experienced increased financial stress, but the BDC has recovered well from the pandemic shock.
Since its inception in 2007, Main Street has consistently increased its net asset value. The BDC’s net asset value was $25.37 as of June 30, 2022, representing a 97% increase since the end of 2007, when Main Street’s net asset value was $12.85.
The lower middle market debt portfolio, which consists primarily of First Liens, is at the heart of Main Street’s investment portfolio.
First liens are the safest type of debt because they are highly secured and have low loss ratios. As of June 30, 2022, First Liens represented 99% of Main Street’s lower middle market portfolio, which was valued at approximately $1.8 billion and included 75 portfolio companies.
The average loan in the LMM portfolio had a fair value of $24.2 million and a cost of $20.1 million. As of June 30, 2022, the weighted average effective debt yield for the LMM tranche was 11.2%.
In addition to the LLM portfolio, Main Street Capital has $1.3 billion invested in a private credit investment portfolio of 82 investments (99% secured debt) and a $364 million middle market portfolio (also 99% secured debt).
Main Street’s investment portfolio continued to perform well in the second quarter, with distributed net income rising 25% year over year to $57.1 million amid a broad economic recovery. Main Street’s distributed investment net income of $0.78 per share, up more than 16% year over year, more than covered BDC’s regular monthly dividend, which cost the company $0.645 per share in the quarter. second-22.
The payout ratio was 83% in the second quarter and 82% over the past twelve months, giving Main Street’s dividend a very high margin of safety.
Internal management translates into lower operating costs
Main Street is an internally managed business development company that sets BDC apart from others in the industry. Internally managed businesses save money on the incentive fees that must be paid to the external manager, resulting in a more competitive cost structure and lower operating expenses.
Main Street can distribute a larger portion of its earnings to shareholders as monthly dividends or special dividends because of lower operating expenses.
According to Main Street, the business development company’s operating expenses are 1.5% of total assets, which is slightly less than half the national average for publicly traded BDCs.
A very generous estimate
Despite Main Street outperforming in terms of net investment income growth, BDC stock trades at such a high net worth multiple that I believe investors are limiting their ability to earn returns attractive long term.
Main Street’s 2Q22 net asset value was $25.37, representing a 69% premium to net asset value. I don’t believe such a high premium is justified given that the stock only yields 6.1%, leading me to conclude that MAIN is significantly overvalued at its current valuation.
Why Main Street could see a higher rating
Main Street is a ‘flight to safety’ stock, meaning that when emotions are high in the market and investors are worried about the economy, for example, they tend to buy quality companies.
Main Street trading at such a high net worth multiple is also due to its reputation as a reliable dividend payer with a strong monthly dividend.
The perception that Main Street is a safe place to park capital can result in an even higher net worth multiple.
Despite Main Street’s strong portfolio and rising net investment income, I believe the business development company’s stock is likely significantly overvalued.
Main Street’s LMM portfolio yields 11.2%, while investors only receive a dividend return of 6.1% based on monthly dividends.
Because Main Street shares trade at a 69% premium to net asset value, I believe income investors’ opportunities to earn attractive total returns are limited.