However, gradual deterioration in asset quality because of prolonged high rates is a headwind and might hurt industry players’ financials in the coming days. Nonetheless, a few players like Kayne Anderson BDC, Inc. KBDC and Bain Capital Specialty Finance, Inc. BCSF are worth a look.
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 a change of ownership transactions, strategic buyouts, recapitalizations and growth initiatives in partnership with business owners, management teams and financial sponsors, among others. Some of the other products offered by the industry participants are mezzanine loans that typically pay high interest rates and can be converted into equity in the target firm.
3 Key Themes to Watch in the SBIC & Commercial Finance Industry
Asset Quality: Following the COVID-19 outbreak and a subsequent halt in business activities in 2020, most sectors wherein SBIC & Commercial Finance companies provide finance were hit hard. This raised fears of a deterioration of asset quality for industry players. Nonetheless, support from the administration in the form of stimulus packages and the subsequent re-opening of businesses supported economic growth. This, thus, prevented a substantial rise in delinquency rates for the industry players.
However, with prolonged higher interest rates, industry players are likely to witness some weakness in asset quality as the portfolio companies might find difficulty in servicing debt. Further, heightened geopolitical risk will put a strain on SBIC & Commercial Finance companies’ asset quality.
Declining Interest Rates: The Federal Reserve has started cutting interest rates. The central bank lowered the rates by 75 basis points (bps) and the market participants expect another 25-bps cut in December. As the interest rates come down, demand for products and services offered by SBIC & Commercial Finance industry players is likely to improve amid solid economic growth and cooling inflation. Thus, the rise in transaction activity is expected to drive total investment income for these companies.
Further, lower rates are expected to lead to a spike in refinancing amid increased competition. So, the industry players will benefit from the same.
Regulatory Changes: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helped these companies reduce portfolio risks by investing in higher capital structures without forgoing current returns. Thus, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks SBIC & Commercial Finance industry is a 34-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #127, which places it in the bottom 49% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is 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 bottom 50% of the Zacks-ranked industries is a result of a discouraging earnings outlook for the constituent companies in aggregate. Looking at aggregate earnings estimate revisions, it seems that analysts are gradually losing confidence in this group’s bottom-line growth potential.
Before we present a couple of stocks that are well-positioned to outperform the market, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Underperforms the Sector and the S&P 500
The Zacks SBIC & Commercial Finance industry has underperformed the S&P 500 composite and its sector over the past year.
The stocks in this industry have collectively risen 8.8% over this period, while the Zacks S&P 500 composite and the Zacks Finance sector have rallied 30% and 30.4%, respectively.
One-Year Price Performance
Industry's Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TB), which is commonly used for valuing loan providers because of large variations in their earnings from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.95X. The highest level of 1.05X, the lowest of 0.42X and a median of 0.92X 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 evidenced by the trailing 12-month P/TB for the S&P 500 composite of 14.47X, 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. Hence, comparing the group’s P/TB ratio with its broader sector ensures that the group is trading at a solid discount. The Zacks Finance sector’s trailing 12-month P/TB of 5.19X is also way above the Zacks SBIC & Commercial Finance industry’s ratio, as shown below.
Price-to-Tangible Book Ratio (TTM)
2 SBIC & Commercial Finance Stocks to Bet on
Kayne Anderson: This Zacks Rank #2 (Buy) firm makes debt investments in middle-market companies (firms with EBITDA in the range of $10-$150 million). Based in Houston, TX, the company has invested almost $11 billion of capital since its inception in 2021.
As of Sept. 30, 2024, Kayne Anderson had total investments (fair value) of $1.94 billion in 110 portfolio companies and net asset value (NAV) per share of $16.70. As of the same date, the company had cash and cash equivalents of $61.8 million (including short-term investments).
Further, at September 2024-end, KBDC had $788 million in outstanding debt. Also, the company had $437.0 million of undrawn commitments available on its credit facilities.
Further, at the end of the third quarter of 2024, Kayne Anderson’s debt-to-equity ratio was 0.66. It targets a debt-to-equity ratio of 1.0 to 1.25. While the company is below its target at present, it expects to continue to grow its private credit portfolio over the coming period to achieve its targeted leverage.
The company’s shares have rallied almost 1% so far this year. The Zacks Consensus Estimate for 2024 earnings has been revised 1.5% upward over the past 30 days. KBDC has a market cap of $1.15 billion.
Price and Consensus: KBDC
Bain Capital: Headquartered in Boston, MA, BCSF is a specialty finance company that primarily invests in U.S. middle-market companies (firms having EBITDA in the range of $10-$150 million). It seeks to invest in senior investments with a first or second lien on collateral, senior first lien, stretch senior, senior second lien, unitranche, mezzanine debt, junior securities, other junior investments and secondary purchases of assets or portfolios.
As of Dec 31, 2023, Bain Capital had a total principal debt outstanding of $1.31 billion, significantly higher than the cash and cash equivalents (including restricted cash) of $59.8 million. The company had $432.2 million of undrawn investment commitments as of Sept. 30, 2024.
The fair value of BCSF’s total investment portfolio was $2.41 billion as of Sept. 30, 2024, and consisted of investments in 159 portfolio companies across 31 different industries. NAV was $17.76 per share on the same date.
Bain Capital has a market cap of $1.07 billion. Shares of this Zacks Rank #2 company have rallied 10.2% so far this year. The Zacks Consensus Estimate for 2024 earnings has moved 1.5% north over the past month.
Price and Consensus: BCSF
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Kayne Anderson BDC, Inc. (KBDC) : Free Stock Analysis Report
Bain Capital Specialty Finance, Inc. (BCSF) : Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
