Business Development Companies (BDCs) have emerged as an enticing domain, offering elevated starting yields, particularly appealing in a climate of heightened interest rates.
In an ideal scenario, a BDC should furnish not only a burgeoning share price over time but also escalating distributions as its portfolio increases in profitability.
Saratoga Investment Corp (NYSE: SAR) stands out in this landscape as a BDC specializing in middle market companies generating revenues between $10 million to $150 million, boasting an EBITDA of at least $2 million.
SAR capitalizes on high cash flows via investments in debt capital strategies spanning acquisitions to growth financing. While SAR hasn’t quite delivered on price appreciation, its total return over the past five years remains compelling. The allure of SAR lies primarily in its income potential, with a starting dividend yield of 12.4%.
Moreover, SAR currently trades at an attractive discount to Net Asset Value (NAV), signaling an opportune entry point. However, lingering concerns persist regarding the credit quality within SAR’s portfolio.
This article aims to delve into SAR’s recent financial performance, internal growth, and risk profile to ascertain its viability for inclusion in a dividend and income-focused portfolio.
Financial Performance
SAR’s Q4 earnings report unveiled an adjusted net investment income per share of $0.94, marginally lower than the prior year’s $0.98 per share. Nonetheless, net investment income witnessed an uptick, escalating from $9.64 million in the previous year’s Q4 to $12.78 million.
Despite these quarterly fluctuations, SAR’s net investment income has witnessed a remarkable upsurge since 2022, nearly tripling in value.
This exponential growth can be attributed to SAR’s strategic allocation towards floating rate debt, comprising approximately 99.5% of its loans. As interest rates soar, so do the interest payments on borrowers’ debts, bolstering SAR’s cash flow prospects.
Conversely, SAR’s fixed-rate debts, coupled with extended timeframes, position it favorably against future interest rate fluctuations.
Portfolio & Risk Profile
An examination of SAR’s portfolio composition reveals a predominant focus on first lien debt, accounting for 85.7% of the total. This strategic stance places SAR at the apex of the repayment capital structure, fortifying its position amidst a backdrop of escalating interest rates.
Furthermore, SAR maintains a highly diversified portfolio spanning 43 different industries, with a pronounced emphasis on healthcare software, IT services, and HVAC services and sales.
This diversification strategy, coupled with a meticulous credit rating system, underscores SAR’s commitment to mitigating concentration risk while prioritizing high credit quality portfolio companies.
Quarterly Dividend
SAR augmented its quarterly dividend marginally by 1% in February, reflecting a current dividend yield of 12.4%, outpacing its peers. With a healthy dividend coverage of 128.7% by Net Investment Income (NII), SAR’s consistent dividend growth trajectory renders it an attractive option for investors seeking a reliable income stream.
However, it’s imperative to note that SAR’s dividend income is classified as non-qualified dividends, rendering it less tax-efficient outside of tax-advantaged accounts.
Valuation & Conclusion
Despite trading below pre-pandemic levels, SAR’s price trajectory remains tethered to its Net Asset Value (NAV), which has experienced a steady decline in recent years. While SAR presents an enticing entry point trading at a discount to NAV, concerns loom regarding its elevated debt levels and modest Return on Equity (ROE).
In essence, Saratoga Investment Corp (SAR) emerges as a formidable BDC proposition, offering a compelling blend of dividend coverage, discounted valuation, and prudent portfolio management.
However, lingering uncertainties surrounding NAV growth and debt levels necessitate a cautious approach, warranting ongoing scrutiny to discern SAR’s trajectory.
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