Pixelimage
Pixelimage
Bain Capital Specialty Finance Inc. (NYSE:BCSF) is a well-managed BDC with substantial excess dividend coverage that could translate into a significant excess cash return potential in 2024.
The BDC raised its dividend twice last year and though the investment portfolio is shrinking, due to higher repayments and headwinds to originations in a high-rate environment, Bain Capital Specialty Finance’s net investment income is more than sufficient to allow for a drastic dividend raise this year.
With a 11% discount to net asset value also available to passive income investors, BCSF also offers some re-rating potential on top of a covered 11.4% yield.
Bain Capital Specialty Finance improved its dividend pay-out metrics last year, partially because of its exposure to floating-rate loans which produced higher net investment income for the BDC in 2023.
This was the reason for me to modify my stock classification to Buy. Taking into account that Bain Capital Specialty Finance continued to shine in the fourth quarter with its dividend coverage, I think that BCSF has considerable potential to hand a number of dividend raises to shareholders in 2024.
Bain Capital Specialty Finance suffered from headwinds to originations in 2023 which were brought on the BDC by the central bank which raised short-term interest rates aggressively in the first half of 2023.
As a consequence, Bain Capital Specialty Finance’s experienced a decline in new investment fundings and higher repayments, leading to a decline in the company’s portfolio value throughout 2023.
As of December 31, 2023, Bain Capital Specialty Finance’s loan portfolio had a total fair value of $2.3 billion, which was down 3.7% YoY. The portfolio consisted predominantly of First and Second Liens which together accounted for 80% of Bain Capital Specialty Finance’s loan investments.
The BDC also retained a large investment allocation to Equity investments, amounting to 15% of all investments, as a means to spice up its total returns.
Invested Portfolio By Asset Type (Bain Capital Specialty Finance)
Bain Capital Specialty Finance did a total of $822 million in new investment fundings in 2023 of which a whopping $691 million related to the First Lien investment category. Sales and repayments totaled $924 million which leads us to a net decline in investment activity of $103 million in 2023.
These trends may change a bit in 2024, however, as the central bank is contemplating short-term interest rate reductions if inflation cools down.
New Investment Fundings By Asset Type (Bain Capital Specialty Finance)
Bain Capital Specialty Finance’s portfolio is robustly diversified, not only in terms of industry, but also in terms of geography, with investments being made outside of the United States in order to improve the BDC’s diversification profile. The present portfolio setup produced a 13.1% yield at fair value and the portfolio is mostly oriented towards floating-rate loans (93.8%).
Portfolio Overview (Bain Capital Specialty Finance)
Bain Capital Specialty Finance’s high excess dividend coverage is driven by a substantial increase in the BDC’s net investment income, thanks to growing interest income. The BDC’s interest income skyrocketed 18% YoY to $62.4 million in 4Q-23 due to interest rate tailwinds provided by the central bank.
Bain Capital Specialty Finance’s net investment income jumped 44% YoY to $34.9 million and the BDC makes more than enough cash to afford some generous dividend raises in 2024.
Quarterly Operating Results (Bain Capital Specialty Finance)
Bain Capital Specialty Finance raised its regular dividend twice in 2023 and I see more dividend hikes coming shareholders’ ways in 2024 as the BDC produces substantial dividend excess coverage.
Bain Capital Specialty Finance earned $0.54 in net investment income in the fourth quarter which compares to a dividend pay-out of $0.42 per share. This translates into a dividend pay-out ratio of 78% in 4Q-23 and a twelve months dividend pay-out ratio of 73%.
Bain Capital Specialty Finance announced a $0.12 per share special dividend in February, to be paid in equal amounts during 2024. In my view, passive income investors could see 1-2 more hikes in the regular dividend this year also.
Dividend (Author Created Table Using BDC Information)
BCSF is still selling for a 11% discount to net asset value which I don’t view as deserved. Bain Capital Specialty Finance’s net asset value as of December 31, 2023 was $17.60, up $0.31 per share YoY.
The NAV of $17.60 represents my intrinsic value estimate since BDCs must mark their loans at fair value. With the dividend being this well-covered by net investment income and the net asset value growing, I think BCSF has a good chance to re-rate to net asset value in 2024, particularly if the BDC makes news with another one or two dividend hikes.
With a 11.4% dividend yield presently provided by the BDC’s stock, I think that passive income investors might potentially be able to earn another 10% on top in capital appreciation.
Bain Capital Specialty Finance is a floating-rate BDC and as such dependent in its net investment income potential on the central bank. Recent inflation numbers have made it very clear that inflation around 3% is here to stay which is delaying some of the rate cuts that the market anticipated.
A faster-than-anticipated return to a more ‘normal’ rate environment, as improbable as it seems right now, would likely be detrimental to Bain Capital Specialty Finance’s net investment income growth in 2024.
Bain Capital Specialty Finance is a well-diversified BDC that experienced sector-specific headwinds in 2023 due to the central bank raising interest rates that weighed on the BDC’s origination activity and led to a higher degree of loan repayments.
Nonetheless, Bain Capital Specialty Finance raised its regular dividend twice in 2023 and the BDC has considerable dividend growth or special dividend potential in 2024 as it maintains a rather high degree of excess dividend coverage.
I think that the 11.4% dividend yield here is quite safe and I would not be surprised to see two generous dividend hikes in 2024 also.
Since BCSF is still selling at a 11% discount to net asset value, I think passive income investors get to lock in a decent margin of safety here as well. Buy.