HomeMost PopularNegative Growth Could Impede Shareholder Returns for BIZD

Negative Growth Could Impede Shareholder Returns for BIZD

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Previously, I spoke highly of business development companies (BDCs) and their ability to provide substantial returns through favorable conditions and portfolios with floating rates. In 2023, BDCs have maintained stable business trends and investor sentiment, with BIZD generating a 15% total return compared to the S&P 500’s 17%. However, there is a concerning trend of negative growth on the horizon that may significantly impact investor returns.

Factors Driving Negative Growth

If a business exhibits sustainable financial growth in the long term, it indicates strong performance, favorable trends, and increased returns for investors. However, two factors – rate cuts and muted portfolio growth – may contribute to negative growth for BDCs in the future.

After experiencing steady growth over the last decade, BDCs’ financial growth accelerated in the past four quarters due to a series of rate hikes. However, this growth is expected to decline in the near term and turn negative in the mid to long term as interest rates peak and return to normal levels.

While rate increases have significantly bolstered income and earnings, rate cuts would have the opposite effect. BDCs with a higher percentage of floating loans will be particularly impacted. For example, Ares Capital could see an 8.5% drop in earnings with a 100 basis point rate cut, while Carlyle Secured Lending’s earnings could decrease by 12% with the same rate cut.

Anticipating rate cuts, investor sentiment plays a significant role in market reactions. Negative growth expectations for any company or industry lead to a decline in investor confidence. The recent stock market trends illustrate how markets react to perception well in advance. Despite no official indication, the S&P 500 regained all 2022 bear market losses in the first half of 2023 due to optimism surrounding an impending shift in the Fed’s policy. BDCs have also underperformed compared to the S&P 500, with BIZD shares only up 8% year-to-date.

Portfolio growth is crucial for long-term income and earnings growth. However, challenging market conditions and increasing non-accrual risk have forced many BDCs to adopt a defensive stance and be selective about new opportunities. BIZD’s largest holding, Ares Capital, saw its portfolio value decline from $21.7 billion to $21.49 billion in the June quarter. Similarly, FS KKR’s portfolio value decreased from $16 billion in June 2022 to $14.7 billion in June 2023.

Despite these challenges, BDCs engaged in venture lending continue to experience robust income and portfolio growth. Hercules Capital recorded an all-time high gross funding in the first half of 2023.

Financial Projections

Financial projections for BIZD’s top 10 holdings, which account for 74% of the portfolio, indicate limited financial upside in the second half of 2023 and negative growth in the following years. Ares Capital is expected to experience declines in earnings in 2024, with the downtrend accelerating in 2025.

There is a high risk of BIZD underperforming in terms of total returns. Although it has provided decent total returns so far, fading growth and increased downside volatility may limit upside potential. Share price drivers such as profitability, portfolio activity, and net asset value are also expected to worsen.

However, the risk of BIZD’s dividends is low as significant earnings growth in previous quarters allows for sustained dividends. Many companies have implemented strategies focusing on maintaining base dividends at a lower level while sharing high profitability through special and supplementary dividends.

In Conclusion

While a steep share price drop may not be imminent, BDCs may struggle to generate market-beating returns. Fear of slow growth and declines in profitability, non-accruals, and portfolio growth are likely to negatively impact share price performance. As a result, I am downgrading my rating for BIZD from a buy to a hold.

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