Updated on March 11th, 2019 by Josh Arnold
Business Development Companies, or BDCs, have become popular among income investors. That is because BDCs, as an alternative asset class, offer very high dividend yields, thanks in part to a favorable tax structure.
For example, Solar Senior Capital (SUNS) has a current dividend yield of 8.3%. You can see the full list of established high-yield dividend stocks by clicking here.
Not only that, but Solar Senior also pays its dividend each month, rather than once per quarter. This allows investors even faster compounding.
Solar Senior is one of fewer than 40 monthly dividend stocks. You can download the full list of monthly dividend stocks from our database below:
Solar Senior offers a high level of income, and a way for investors to gain exposure to privately-held companies with the potential for growth.
It certainly isn’t without risks, but for those investors that can stomach a bit of uncertainty, Solar Senior’s yield may be worth it.
Business Overview
BDCs make debt or equity investments in companies that have not yet gone public, which are typically at an earlier stage of development and require growth financing.
They offer a way for people to invest in private companies without having to gain accredited-investor status. In addition, BDC’s generally have widely diverse portfolios, offering investors the protection of diversification by simply owning the BDC rather than many smaller investments.
Solar Senior Capital is a value-oriented investment company. It invests predominantly in senior secured debt of privately-held middle market companies.
Source: Investor Relations
The company targets investments in entities with revenues of at least $50 million and EBITDA of at least $15 million, offering a measure of safety.
Companies that meet these needs are generally well established and therefore offer less risk during a downturn, for instance.
Solar Senior generally invests $5 to $20 million of its capital in each position, meaning its portfolio is never too concentrated on one or a handful of positions.
This helps the company diversify away its risk from portfolio concentration.
Source: Investor Relations
As of the end of the 2018, Solar Senior had a $534 million investment portfolio. Out of the $534 million, 92% is in floating rate instruments.
The portfolio’s total yield is also very attractive in excess of 10%. The bulk of the portfolio, which is based on cash flow first lien senior secured loans, yields just over 8%, while some higher-risk bets make up the remainder of the loan book, and boost the average yield.
This sort of portfolio yield is very attractive and helps Solar Senior pay its large distribution.
Source: Investor Relations
Solar Senior’s diversification and scale can be seen here as the company is invested in 161 different entities across 89 industries. This diversification provides protection against economic weakness in particular sectors and against shocks from potential weakness from a single customer or group of customers.
Growth Prospects
One of the ways Solar Senior can generate growth is through new investment. The company has a sizable amount of capital left on the balance sheet.
Solar Senior ended 2018 with more than $200 million of available capital, subject to its borrowing base limitations.
The growth prospects for Solar Senior are reliant upon the health of its investment portfolio. Should its investments perform well, Solar Senior will report higher levels of net investment income, which then translates into higher shareholder dividends.
Full-year 2018 results were flat to 2017’s results, which is consistent with how the company has performed in recent years. Net investment income was $1.41 per share in 2018, which is the same value as 2017, and fractionally lower than that of 2016. Growth, in other words, has been challenging to come by for Solar Senior.
Net asset value ended the year at $16.30 per share, which compares somewhat favorably to the company’s current share price of $16.96.
As a result of the company’s slight premium to net asset value, we don’t see valuation expansion as a significant source of returns for shareholders in the coming years.
Given the rates of investment and divestiture have been roughly equal in recent quarters, Solar Senior appears not to be focused on growing the portfolio at this time.
However, that could change, and likely will, as over time, Solar Senior’s portfolio has expanded. This growth has been lumpy, however, and is dependent upon when the company sees attractive opportunities to deploy capital.
Management remains committed to paying the distribution, as a cut in the payout would likely result in a significantly lower valuation for the stock.
Dividend Analysis
BDCs are considered pass-through securities, which means they are generally not taxed at the company level. This allows them to make high levels of distributions to investors, which results in their hefty dividend yields.
Shareholders are taxed on distributions, although one of the advantages of BDCs is that investors do not have to deal with K-1s each year. Instead, they are required to submit a 1099-DIV.
Solar Senior continues to pay a monthly distribution of $.1175 per unit, which it has done since September of 2012. This comes out to an annualized distribution of $1.41 per unit. While the lack of dividend increases may be off putting to some investors, the distribution hasn’t been cut or suspended, and the yield is still quite robust.
Based on Solar Senior’s recent unit price of $16.96, the stock has a yield of 8.3%.
Solar Senior is not an attractive choice for dividend growth investors, given its flat distributions. However, it offers a very hefty yield, more than four times the average dividend yield in the S&P 500 Index.
In addition, given that net investment income fully covers the dividend, albeit only barely, the yield appears to be sustainable. If there is a significant downturn in the performance of the company’s portfolio, the yield would almost certainly be at risk.
However, dividend coverage has been near 100% for years and there hasn’t been a cut, so we remain relatively optimistic.
Final Thoughts
Solar Senior’s distribution coverage is tight right now, but that has been the case for many years. As a BDC, it will always pay out most or all of its income to shareholders, so coverage will never be low.
The company has invested for future growth, although shareholders haven’t yet reaped the rewards from those investments.
Investors interested in high-yielding BDCs could find Solar Senior to be an attractive stock. Certainly, this is not an appropriate investment for those seeking dividend growth, but for an 8%+ yield and a soundly managed company, Solar Senior may fit the bill.
