Main Street Capital: Buy This Blue-Chip BDC And Sleep Like A Baby (NYSE:MAIN)

If you’re reading this and human like everybody else, I’m sure that you have had at least a few sleepless nights in your life for various reasons. Perhaps you lost your job, you got divorced, or maybe you or a loved one received a daunting medical diagnosis.

Whatever the reason may be, my goal here on Seeking Alpha is to help the audience to not lose sleep over finances. We’ve all probably heard the general advice a million times about living below your means and having an emergency fund. But the one thing that I didn’t learn about until I was 12 years old was what would forever change the trajectory of my life – – dividends.

Beyond the typical financial advice, constructing a portfolio of passive income stocks can help you to sleep the most sound you’ve slept since you were a baby. As the only monthly dividend payer in my portfolio besides Realty Income (O), Main Street Capital (NYSE:MAIN) is the sixth-largest individual stock in my portfolio, making up 2% of my total dividend income. Without further ado, let’s highlight MAIN’s fundamentals, risks, and valuation to grasp why I like the stock so much and rate it as a buy.

An Established Dividend Growth Track Record

MAIN yields a whopping 7% (not counting special dividends), which is almost double the financials sector median of 4%. Thus, it shouldn’t be a surprise to find out that the company earned an A grade for forward dividend yield from Seeking Alpha’s Quant system.

Given the remarkable starting dividend, MAIN has to be lacking in dividend growth, right? No, it’s also been a solid dividend grower. MAIN’s dividend has grown by 4% annually over the last 10 years, which earns it a C- grade for 10-year dividend growth relative to the financial sector median of 8%.

The best part is arguably that this exceptionally generous dividend is very sustainable. That is because MAIN generated $2.19 in distributable net investment income per diluted share in the first half of 2023. Against the $1.75 in total dividends per share distributed during that time, this is a payout ratio of just 79.9%. That leaves the company with a margin of safety to maintain its dividend even if an economic downturn materializes. This explains how MAIN’s regular quarterly dividend per share rate has skyrocketed 114% from $0.33 in Q4 2007 to $0.705 for Q4 2023. Since its IPO in 2007, the company’s dividend has never decreased – – not even during the Great Recession or the COVID-19 pandemic.

Taking its manageable payout ratio into consideration and at least mid-single-digit annual DNII per diluted share growth, I believe MAIN can deliver an average of 4% annual dividend growth to shareholders indefinitely.

Business Is Booming

MAIN is a BDC that mostly invests in lower-middle market companies through a mixture of debt and equity. These are businesses with between $10 million and $150 million in annual revenue and annual EBITDA between $3 million and $20 million. In recent decades, traditional financial institutions like banks have become more skeptical of lending these businesses money.

This has prompted the nearly 200,000 LMM businesses in the U.S. to more heavily rely on BDCs like MAIN for their capital needs. That has helped MAIN to grow its capital under management to $6.7 billion as of June 30, including $5.1 billion managed internally and $1.6 billion as an investment advisor to external parties. The company’s massive investment portfolio is also well-diversified, with its investments spread across 195 companies in dozens of industries.

Unlike many businesses, MAIN is thriving in the current high interest rate environment. This is because 71% of the company’s outstanding debt is locked in at fixed interest rates. That has at least somewhat limited MAIN’s growth in interest expenses. Better yet, 70% of the company’s debt investments bear interest at floating rates, meaning it benefits from high and rising interest rates. For these reasons, MAIN’s DNII per diluted share climbed 42.2% over the year-ago period to $2.19 in the first half of 2023.

The cherry on top for the company is that it enjoys BBB- investment-grade credit ratings from S&P and Moody’s. This allows the company to generate healthy investment spreads between what its cost of capital is and what it generates in interest and dividend income from its investment holdings (all details in this section sourced from MAIN Q2 2023 Investor Presentation and MAIN Q2 2023 earnings press release).

Risks To Consider

In just about every metric that matters, MAIN is a top-notch business. As my fellow Seeking Alpha writers Dividend Sensei and Brad Thomas point out, there are 20-plus pages of risk factors included in its annual report.

MAIN is cashing in on high interest rates for the time being: The company estimates that for every 100 basis point increase in interest rates, its DNII per diluted share rises by $0.18. But the reverse will also be true when interest rates eventually come falling back down to earth (figure sourced from slide 44 of 49 of MAIN Q2 2023 Investor Presentation).

The same approach from the Federal Reserve that is helping MAIN could also end up hurting it eventually. This is because a recession is looking more likely by the day, which could result in the default of some of the company’s investment holdings, weighing on results in the near future.

A Decent Value For An Iconic BDC

Even with shares of MAIN rallying 16% in the past 12 months, the stock looks like it could still be enticing for income investors based on a valuation model.

The valuation model that I’ll utilize is the dividend discount model or DDM. This consists of three inputs.

The first input for the DDM is the annualized dividend per share, which is $2.82 for MAIN (excluding special dividends).

The next input into the DDM is the cost of capital equity, which is another term for the annual total return rate required by an investor. I seek 10% annual total returns, so 10% is what I will use.

The final input for the DDM is the annual dividend growth rate. As I noted earlier, I will assume a 4% annual DGR.

These inputs into the DDM give me a fair value output of $47 a share. That suggests that MAIN’s shares are priced 13.5% below fair value and offer 15.6% capital appreciation from the current price of $40.64 a share (as of September 28, 2023).

Summary: Main Street Capital Fits Like A Glove Into An Income Portfolio

MAIN is a superb dividend growth stock. The company’s reputation for dividend growth, viable payout ratio, and growth prospects could make it worthy of consideration for income investors.

This is especially the case when considering that MAIN appears to be undervalued by a double-digit percentage. That is why I rate shares of the stock a buy for income-oriented investors.