High Rates: The Federal Reserve aggressively raised interest rates since March 2022 to control high inflation. Though the central bank has signaled rate cuts in 2024 as the inflation numbers continue to cool down gradually, the rates are likely to remain high for a prolonged period. As the higher rates lead to a spike in prepayments and refinancing, this will keep benefiting SBIC & Commercial Finance industry players.

However, the demand for products and services offered by these companies is likely to moderate on the back of a challenging macroeconomic backdrop and increased competition. Thus, the industry players’ revenue growth is expected to be hampered in the upcoming period.

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 foregoing current returns. Thus, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.

Zacks Industry Rank Indicates Gloomy Picture

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 #188, which places it in the bottom 25% 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 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 appears that analysts are gradually losing confidence in this group’s bottom-line growth potential. Since October 2023-end, the industry’s earnings estimates for the current year have been revised 2.3% lower.

Before we present a few stocks that are well-positioned to outperform the market despite near-term weakness, 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 both the S&P 500 composite and its sector over the past year.

The stocks in this industry have collectively risen 14.7% over this period, while the Zacks S&P 500 composite and the Zacks Finance sector have rallied 27.5% and 24.3%, respectively.

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/TBV), 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 0.93X. The highest level of 1.03X, the lowest of 0.41X and a median of 0.90X 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 11.09X, as the chart below shows.

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. However, comparing the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a solid discount. The Zacks Finance sector’s trailing 12-month P/TB of 4.60X is also way above the Zacks SBIC & Commercial Finance industry’s ratio.

3 SBIC & Commercial Finance Stocks Worth Considering

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 $1.3 billion, significantly higher than the cash and cash equivalents (including restricted cash) of $112.5 million. The company had $266.1 million of undrawn investment commitments as of Dec 31, 2023.

The fair value of BCSF’s total investment portfolio was $2.3 billion as of Dec 31, 2023, and consisted of investments in 137 portfolio companies across 31 different industries. Net asset value (NAV) was $17.60 per share on the same date.

Bain Capital has a market cap of $1.01 billion. Shares of this Zacks Rank #2 (Buy) company have jumped 29.1% over the past year. The Zacks Consensus Estimate for 2024 earnings has moved 3.5% north over the past month. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Barings BDC: The company invests in syndicated senior secured loans, bonds and other fixed-income securities in performing, well-established middle-market businesses operating across a wide range of industries located primarily in the United States. This Zacks Rank #2 company also has investments in middle-market companies located outside the country.

As of Dec 31, 2023, Barings BDC had total investments (fair value) of 2.5 billion and NAV per share of $11.28. Further, at December 2023-end, BBDC had $1.4 billion of total debt outstanding. This is significantly higher than cash and foreign currencies of $70.5 million as of Dec 31, 2023.

Over the years, this Charlotte, NC-based company has grown through acquisitions. Some of the notable ones include MVC Capital, Inc. and Sierra Income Corporation. These have helped bolster its market share over time.

The company’s shares have rallied 18.9% over the past year. The Zacks Consensus Estimate for current-year earnings has moved 1.7% upward over the past 30 days. BBDC has a market cap of $969.5 million.

Crescent Capital: This is a specialty finance company mainly focused on originating and investing in the debt of private middle market companies principally located in the United States. Carrying a Zacks Rank #2, CCAP offers capital solutions to companies with sound business fundamentals and strong growth prospects.

As of Dec 31, 2023, Crescent Capital had total investments (fair value) of $1.6 billion (in 186 portfolio companies). Of the total investment value, 61.5% was Unitranche first lien. As of the same date, NAV was $20.04 per share.

Los Angeles, CA-based company had a debt of $844.7 million. It had $24.5 million in cash and cash equivalents and restricted cash and $329.7 million of undrawn capacity on its credit facilities.

Crescent Capital has a market cap of $629.8 million. Over a year, the company’s shares have risen 21.4%. The Zacks Consensus Estimate for 2024 earnings has been revised by 3.2% north over the past 30 days.

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