In a market where interest rates are at highs, there are a lot of stocks that are at risk. Main Street Capital (NYSE:MAIN) is one that has weathered the storm and shareholders are now benefiting from a yield anywhere from 7-10% depending on the supplemental dividends being paid out. Main Street Capital has a strong portfolio that leads to strong income generation thanks to management investing in quality businesses at floating interest rates. While I don’t think there are a ton of capital gains to be had, I do think Main Street Capital is a buy based on the dividend alone. This is a safe place to hide in a turbulent market.
What Is Main Street Capital?
Main Street Capital Corporation is a business development company (BDC) that specializes in equity capital to lower middle market companies. BDCs provide capital needed for projects, and in return, they receive an ownership position or a debt stake yielding above-average interest rates. With respect to Main Street Capital, they focus on businesses with revenue between $10-150 million, and EBITDA of $3-20 million. They currently have over $6.8 billion in capital under management. Looking below you can see just how diverse the portfolio is.
If you are looking for an investment to combat rising interest rates, look no further. Main Street Capital’s income only increases as rates go up. Which leads to them paying a strong dividend. More on that later. But, one of the things you want to see in dividend payers is dependable income. 75% of Main Street Capitals’ outstanding debt obligations have fixed interest rates while 70% of Main Street Capitals’ debt investments bear interest at floating rates. This helps keep costs down while allowing them to benefit from the rising rate environment we have seen in the last couple of years. A perfect combination. Looking below, you can get an idea of how this works with respect to basis point changes in interest rates.
With respect to how this has mapped itself out over the last few years, you can see below just how much of a surge there has been in investment income as rates move up. YTD, they have generated 41% more income. BDCs must meet certain requirements to keep their special status and avoid having to pay taxes at the corporate level. One of these is that they must distribute at least 90% of their taxable income to shareholders annually in the form of dividends. That is where Distributable Net Investment Income (DNII) comes in. The larger the DNII, the greater the payout must be to maintain its special tax status.
Because of this, I do think we will continue to see strong dividend growth out of the company. This will lead to increased income for shareholders with minimal downside risk. Not to say there are no risks, but in the meantime, let’s explore just how good this dividend is.
How About That Dividend?
If you are looking for a stock to hook you up with capital gains, move along. Main Street Capital is not for you. If you are looking for steady, reliable income. Welcome home. Currently yielding 7.0%, Main Street Capital is amongst one of the best options out there. The stock pays a monthly dividend of $0.24 per share after the increase announced on November 1st. This takes effect in Q1 (Jan, Feb, Mar) and represents a 6.7% increase from Q1 23. This is also the 5th increase in the last 6 quarters. Pretty impressive track record.
Looking below, we can see the annual payout over the last handful of years. They have never cut the base dividend, and it has increased 118% since IPO in late 2007. Granted some systematic economic downfall, we will set a new all-time high dividend of $2.88 in 2024. But, I do expect the increases to continue meaning we will likely see even more than $2.88 paid out in 2024.
Oh, what’s that? Special or “supplemental” dividends you say? Why yes! Often forgotten about is the rich history Main Street Capital has with supplemental dividends. The company has paid or declared, including supplemental dividends, since IPO, through the first quarter of 2024 equal $39.54 per share. To put that in perspective, the stock is currently trading at just over $40.00 per share. Pretty incredible stuff. The most recent supplemental dividend for December results in an additional 35% paid out to shareholders over the last 12 months. This brings the actual yield closer to 10%, which is hard to find anywhere. Even better news? It’s already expected that they will be handing out another supplemental dividend in Q1 24.
How secure is the dividend? Well, if paying out excess cash to shareholders serves as any indication, it’s very safe. Main Street Capital uses distributable net investment income (DNII) to determine how much it can afford to pay out. In Q3, DNII exceeded the monthly dividends by $0.35 per share, or 51% and the total dividends by 8%. It is because of the positive outlook on DNII going forward that the company can already anticipate further supplemental payouts. Even when we saw DNII fall in the Covid years, the company did not cut the base dividend, and as you can see above, quickly reinstated supplemental dividends. This is one of many reasons you can sleep well with Main Street Capital in your portfolio.
What Are The Risks?
I see two potential risks. The first being the ownership of the stock. Looking below, you can see that the general public owns 75.6% of the float. While many of that are going to hold for life and just collect the dividend, there is a possibility that there is an irrational rush for the exit should the economy take a turn for the worse. Yes, this potential exists if it’s heavily institutional, but historically the general public acts more based on crowd thinking than taking a look at the fundamentals. Just something to be aware of.
The second risk is when the economy eventually improves, and interest rates start to come back down. While I don’t think we will see 2% rates again anytime soon, any change does affect the bottom line. As mentioned earlier with respect to general sensitivity, their debt is fixed while their income is floating, so this would only hurt the bottom line. I do expect to see rates start to slowly come down in 2024.
That said, I do think the portfolio is diverse enough that the impact is minimal and long-term, Main Street Capital will come through any rate changes and continue to reward shareholders with a very healthy dividend.
What Does The Price Say?
If you have read my work before, this is the part in the article where I talk about the technical side and just how much upside or downside I anticipate. However, with a stock like Main Street Capital, you are really just buying for the dividend. I don’t really see any huge moves coming with respect to capital gains. This stock is a steady engine and is focused on generating income for its shareholders.
That said, I want to make sure investors still have stops in place. Even though the dividend wasn’t cut in 2020, the stock still dropped ~70% with everything else in sight.
Looking above, we can see that the stock has generally been fairly stable outside of some isolated peaks and valleys. The 200-day moving average has been a pretty good point of support and resistance, and we can see the stock is surfing right along that level currently. With respect to stops, I would have them in at $36.50 & $34.50. This gives you the option to maintain a smaller position should your first stop get triggered while waiting to see what direction we go from there.
With respect to the upside, we need to see another test of $42.80. This is only 6% from current levels. A breakthrough here can lead us to $45.00 and beyond. Having tested $42.80 twice this year and having pretty fierce rejections means a breakthrough should form pretty heavy support there. Something to keep an eye on for sure.
That said, no one is buying Main Street Capital for short-term capital gains. If you are buying, you are buying to collect the dividend for the long term. I still think it is important to have stops in place due to how fragile the economy seems to be, but you can sleep well at night letting the dividend pile up.
As you can see, this is a stock that many own simply for the dividend, and I would recommend adding it to any income portfolio. Many are on the hunt for yield, and this is a great option that should hold strong in the current market. I believe you can rest easy knowing that you’re collecting a well-covered dividend over the next couple of years. Main Street Capital is well diversified and will fly through any sort of interest rate turbulence smoothly.