If there was any segment that took a beating in 2014 in addition to the energy sector, it was the business development companies (BDCs). Between being removed from indexes during a Russell rebalancing in the first half of the year to investors’ concern over their exposure to energy in the second half of the year, the stocks were hit, and hit hard. A new report from Oppenheimer maintains that their fundamentals remain outstanding, and most top BDCs have little exposure to energy. Some have outstanding embedded portfolio gains to offset any weakness.
BDCs typically have loans out to a wide portfolio of companies, and while they are not high-yield bond funds, the do own leveraged loans that are correlated to the high-yield market. With the biggest concern still energy exposure, the Oppenheimer team feels that the selling is way overdone, and there are outstanding opportunities as the group is trading at a discount to net asset values (NAVs). BDCs, like real estate investment trusts, have to pass through 90% of taxable income to investors. The income can include a return of principal.
We screened Oppenheimer’s universe of BDCs rated Outperform for the five top stocks that may provide the best opportunities for investors now.
Capitala Finance Corp. (NASDAQ: CPTA) invests primarily in traditional mezzanine, senior subordinated and uni-tranche debt, as well as senior and second-lien loans and, to a lesser extent, equity securities issued by lower and traditional middle-market companies. Trading at 0.91 times NAV, the company does have 13% of assets in energy now. The analysts point out that the company has substantial gains built in to the portfolio to offset possible energy declines.
Capital Finance investors are paid a 10.07% distribution. The Oppenheimer price target is $20. The Thomson/First Call consensus price target is $21. Shares closed Wednesday at $18.75.
Fidus Investment Corp. (NASDAQ: FDUS) provides customized debt and equity financing solutions to lower middle-market companies, which they generally define as U.S.-based companies having revenues between $10.0 million and $150.0 million. The company’s investment objective is to provide attractive risk-adjusted returns by generating both current income from debt investments and capital appreciation from equity-related investments. While trading at a slight premium to NAV, it also has substantial portfolio gains built in to protect against losses.
Fidus Investment investors are paid a 9.35% distribution. The Oppenheimer price target is $16, while the consensus target is much higher at $19. Shares closed Wednesday at $16.18.
Garrison Capital Inc. (NASDAQ: GARS) invests primarily in the debt and equity of middle-market companies to generate current income and capital appreciation. The company has a beta of 0.04, indicating almost independent movement of its stock relative to the market. The low beta will likely give investors some protection during a market downturn as the company’s stock will not follow the general market reaction, but instead provide returns on the basis of its underlying fundamentals. With very low energy exposure and trading at a 0.98 discount to NAV, it is a very solid investment.
Garrison Capital investors are paid a 9.5% distribution. The Oppenheimer price target is $16, while the consensus target is set at $16.25. The stock closed Wednesday at $14.77.
New Mountain Finance Corp.‘s (NYSE: NMFC) investment objective is to generate current income and capital appreciation through the sourcing and origination of debt securities at all levels of the capital structure, including first- and second-lien debt, notes, bonds and mezzanine securities. In some cases, investments may also include small equity interests. The Oppenheimer team is very impressed with the company’s excellent through-the-cycle underwriting standards. Trading just above the current NAV, the strict standards should help to protect investors.
New Mountain Finance shareholders are paid a 9.15% distribution. The Oppenheimer price target is $15, and the consensus is at $15.08. Shares closed at $14.92.
TCP Capital Corp. (NASDAQ: TCPC) lends primarily to companies with established market positions, strong regional or national operations, differentiated products and services and sustainable competitive advantages, investing across industries in which it has significant knowledge and expertise. TCP’s investment objective is to achieve high total returns through current income and capital appreciation, with an emphasis on principal protection. The low exposure to oil investment makes it a top company to consider, as it trades at a slight premium to NAV.
TCP Capital investors are paid an 8.8% distribution. Oppenheimer has an $18 price target, the same as the consensus objective. Shares closed Wednesday at $16.52.
The Oppenheimer report points out that because of the long-running pricing weakness, new investors are able to buy stocks now at cyclically high yields and very good pricing, often below or at NAV, especially relative to other high-yield investments.