The Zacks SBIC & Commercial Finance industry will continue to bear the brunt of relatively low interest rates and a rise in prepayments. These are likely to keep 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 that supported the firms in which these companies invest have aided credit quality. So, few industry players like Main Street Capital Corporation MAIN, Golub Capital BDC, Inc. GBDC and Trinity Capital Inc. TRIN 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 Major Factors Shaping the Future of SBIC & Commercial Finance Industry
Solid Asset Quality: Following the coronavirus outbreak and subsequent halt in business activities in 2020, the majority of sectors wherein SBIC & Commercial Finance companies provide loans were hit hard. This had raised fears of a deterioration of asset quality for industry players. Nonetheless, support from administration in the form of stimulus packages, extensive vaccination drive and re-opening of businesses continue to support robust economic growth. These are likely to prevent a substantial rise in delinquency rates for the industry players, though red-hot inflation remains a concern.
Regulatory Changes: 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.
Relatively Low Rates: Earlier this month, for the first time since 2018, the Federal Reserve hiked the interest rates and has signaled a hawkish stance to tame the raging inflation. Despite this aggressive stance, interest rates will remain relatively low. This will, thus, continue to hurt SBIC & Commercial Finance stocks’ top-line growth. Also, there is a chance of a spike in prepayments and refinancing before interest rates climb. This is also expected to hamper these companies’ profitability to some extent.
Zacks Industry Rank Indicates Bright Prospects
The Zacks SBIC & Commercial Finance industry is a 37-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #77, which places it at the top 31% 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 10% 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 17.8% over this period, the Zacks S&P 500 composite and Zacks Finance sector have rallied 16.3% and 12.1%, 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 0.91X. The highest level of 1.09X, lowest of 0.41X, and a median of 0.94X 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 16.01X, 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 4.58X 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 Bet on
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 LMM companies that generate annual revenues between $10 million and $150 million.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
As of Dec 31, 2021, Main Street Capital had total investments (fair value) of $3.25 billion in 184 portfolio companies, 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 $25.29 per share.
At the end of the December quarter, Main Street Capital had total liquidity of $567.6 million, which included $32.6 million in cash and cash equivalents and $535.0 million of unused capacity under its revolving credit facility. As of Dec 31, 2021, MAIN had total debt worth $1.48 billion, consisting of debentures and senior notes.
Since its October 2007 initial public offering (IPO), Main Street Capital has regularly raised its monthly dividends. Cumulatively dividends paid or declared since IPO through the second quarter of 2022 stand at $33.54 per share.
Main Street Capital has a market cap of $3 billion. Over the past 12 months, MAIN stock has gained 7.7%. The Zacks Consensus Estimate for earnings has been revised 6.7% upward to $2.57 for 2022 over the past 30 days.
Price and Consensus: MAIN
Golub Capital BDC: This Zacks Rank #2 stock makes investments mainly in one stop (a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans) and other senior secured loans of middle-market companies. Based in New York, the company invests roughly $10-$75 million of capital.
Following the acquisition of Golub Capital Investment Corporation in September 2019, Golub Capital became the fifth largest externally managed, publicly-traded business development company in the United States in terms of assets. The deal continues to support the company’s financials.
As of Dec 31, 2021, Golub Capital had total investments (fair value) of $5.15 billion in 301 portfolio companies and NAV per share of $15.26. As of the same date, the company had cash, cash equivalents and foreign currencies of $182.7 million and restricted cash, cash equivalents and foreign currencies of $118.8 million. Further, at December 2021-end, GBDC had $2.9 billion in outstanding debt.
The company’s shares have rallied 1.1% over the past year. The Zacks Consensus Estimate for earnings has been unchanged at $1.24 for fiscal 2022 over the past month. GBDC has a market cap of $2.6 billion.
Price and Consensus: GBDC
Trinity Capital: Headquartered in Phoenix, AZ, TRIN is a specialty lending company that provides debt, including loans and equipment financings, to growth stage companies. These growth companies, which have expected revenues of up to $100 million, include venture-backed companies and companies with institutional equity investors
As of Dec 31, 2021, Trinity Capital had total investments (fair value) worth $873.5 million in 94 portfolio companies and NAV of $16.40 per share. Of the total investment value, $551.9 million was in secured loans, $184.1 million in equipment financings and $137.5 million in equity and warrants.
Also, as of the same date, TRIN had almost $254.8 million in available liquidity, including $31.7 million in unrestricted cash and cash equivalents. At 2021-end, it had nearly $223.1 million in available borrowing capacity under its credit facilities.
Earlier this month, the company announced an 11.1% hike in the quarterly dividend to 40 cents per share. Along with this, Trinity Capital declared a new supplemental cash dividend of 15 cents per share for the first quarter. Both these dividends will be paid out on Apr 15 to shareholders of record on Mar 31. The company also plans to declare 15 cents per share as special dividends in each of the remaining quarters of 2022. Thus, this makes the stock an attractive pick for investors.
Trinity Capital has a market cap of $19.8 million. Shares of this Zacks Rank #2 company have surged 31.3% over the past year. The Zacks Consensus Estimate for 2022 earnings has moved 2.9% north to $1.76 over the past 30 days.
Price and Consensus: TRIN
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