Barings BDC: This 11.4% Yielding BDC Looks Like A Future Superstar (NYSE:BBDC)

Introduction

When you think of superstars in certain sectors whether it be tech, real estate investment trusts, or business development companies, there are certain names that instantly come to the minds of investors. And while those investments are great, finding those with the makings of a future superstar are always better because they normally trade at more attractive valuations.

The more known, higher-quality stocks usually command a premium, whether that’s to its NAV or book value. Especially when looking in the BDC sector (BIZD) where many BDCs currently trade at large premiums above their NAV prices.

Well, one that I recently came across that although it’s smaller and lesser-known, it has all the makings of a future player in the sector and that’s Barings BDC (NYSE:BBDC). And in this article I discuss why this BDC may be one income-focused investors consider for their portfolios.

Who Is Barings BDC?

Like many of its peers, BBDC is a business development company that lends to middle market companies. These are typically in the form of debt investments and they usually lend to companies with smaller EBIDTAs that don’t have access to capital from large banks like JPMorgan (JPM) or Bank of America (BAC).

Additionally, they are on the smaller side in comparison to those like ARCC & BXSL with a market cap of less than $1 billion and total portfolio value of $2.49 billion.

For BBDC, they typically target companies with an EBITDA of $10 million to $75 million. They are also externally-managed, similar to peers, Ares Capital (ARCC) and Blackstone Secured Lending (BXSL). Their external manager Barings, LLC is a credit-focused manager with more that $300 billion in assets under management.

For those who are new to BDCs, they can be either internally or externally-managed. Some investors prefer those that are internally-managed as they don’t have to pay fees (to an external manager), hence the name externally-managed. And sometimes these fees can be pretty expensive.

However, some have management fees to align more with shareholders, thus making them more attractive investments. One who recently lowered their fees is Golub Capital (GBDC). I touched on this in a recent article regarding how it would impact their NII going forward which you can read here.

What Immediately Jumped Out

When researching Barings BDC, the first thing I looked for was something concerning with the business. The main thing I wanted to check was the BDC’s non-accrual status. Although many now trade at premiums above their NAV as a result of rewarding shareholders with specials and/or supplementals because of higher interest rates and their predominantly floating-rate portfolios. But this has also been a headwind for portfolio companies as well.

And being that they are smaller, I expected to see a good number of loans on non-accrual status. Some larger, more well-known peers have seen their non-accruals rise significantly as a result of the current economic backdrop. One that comes to mind is FSK KKR Capital Corp (FSK) whose non-accruals accounted for 5.1% at cost and 2.6% at fair value.

This is above the KBW BDC average of non-accruals. Additionally, for those with higher non-accruals, this also is a testament to the credit quality of their portfolio companies. What I liked about BBDC is that they typically avoid sectors that are highly susceptible to economic downturns like oil & gas, restaurants, and retail.

They also have a good amount of first-lien investments at 67% and 74% invested in senior-secured investments. This puts them in a better financial position to navigate not only the macro environment, but unsuspected downturns as well.

Financials

Barings BDC reported their Q4 earnings at the end of February to close out the fiscal year and reported some decent numbers with net investment income of $0.31. This remained flat quarter-over-quarter, but rose from $0.25 in Q1. However, this was down from $0.34 at the end of 2022.

Moreover, total investment income grew quarter-over-quarter and year-over-year by 7% & 19.4% respectively. Their NAV price also grew nicely, following their Tll growing from $11.17 in Q1 to $11.28 in Q4. For a BDC, healthy NAV growth quarter-over-quarter is always good to see for investors. This shows not only that the BDC financials remain strong, but that the company continues to grow their portfolio and out-earn their dividend.

So, to close out the year BBDC numbers were decent considering the challenging economic backdrop. For many, the current environment has been difficult, making it harder to grow their portfolios by making attractive, accretive investments.

Because of the high interest rate environment, private equity buyers have been reluctant, impacting many BDCs in the process. But as tightening is expected to ease in the foreseeable future and the higher cost of borrowing expected to drop, this will impact those like Barings BDC positively in the near future. And volume will most likely pick back up later this year and more so in 2025.

Strong Dividend Coverage & Buybacks

Another testament to the management team and BBDC’s financial strength is their dividend coverage and the fact that management bought back a substantial amount of shares. Aside from Q1 when dividend coverage was tight, NII covered the dividend payout with an average coverage ratio of 115.5%.

But the thing that impressed me the most was the significant amount of shares repurchased by management. For the full-year they repurchased 1.8 million shares and nearly 450,000 in the fourth quarter alone. Some BDCs have been known to do this, but this is something that is not all that common within the sector. Furthermore, management announced an additional $30 million repurchase program for 2024.

BDCs typically issue shares to raise equity, especially when their prices trade at higher premiums as this is accretive for the company. But by seeing the amount of shares repurchased, this tells me management thinks the market is pricing the BDC too low and they are taking advantage of the cheap valuation.

Well-Laddered Debt

BBDC also has a strong balance sheet with well-laddered debt maturities and none to worry about until the second half of 2025. This puts them in a good position financially. It also gives them the flexibility to help out portfolio companies if they experience unexpected financial stress in the not too distant future.

Their interest coverage and net-debt-to-equity ratios were also strong at 2.2x and 1.15x respectively. Their 2025 total debt amount of $112.5 million had weighted-average interest rates of 4.66% & 4.25% respectively. I think it’s safe to assume interest rates will likely be much lower by then, and probably closer to 2% to 3%.

Discount To NAV

At the current price of roughly $9 a share at the time of writing, this gives BBDC a P/NAV ratio of 0.81x. This is in comparison to peers Capital Southwest (CSWC) & Blackstone Secured Lending, who trade at price to NAV ratios of 1.46x and 1.18x respectively.

Several other BDCs like Ares Capital and Golub Capital also trade at premiums to their NAV prices. At the current discount of roughly 24%, BBDC’s discount to NAV currently sits above their 3-year average of roughly 16% further signaling the BDC may be undervalued and an attractive buy here.

Furthermore, they do offer some upside to their price target of $10 a share and Wall Street currently rates the BDC a buy which I agree with due to their solid fundamentals.

Risk Factors

Despite solid financials and non-accruals declining year-over-year, BBDC did see a rise in PIK income over the same period with this increasing from 3,582 to 5,085 at the end of Q4. For those unfamiliar with PIK income, this is other forms of payments other than cash. A significant rise in PIK income is something BDC investors should keep a close eye on, especially with interest rates remaining higher for longer as this could impact the company’s financials going forward.

And this could also be an indicator of increased risk of portfolio companies defaulting on loans. One thing of note however, some BDC management teams structure PIK income into their deals on the front end with portfolio companies but most prefer to be paid in cash. So, while rises in PIK income are not all bad, it could be an indicator of financial stress, and if its continues to increase significantly, this may be something that could cause concern.

Investor Takeaway

Despite challenges caused by the macro environment, Barings BDC navigated quite well, not only showing their quality management team, but their portfolio credit quality as well. I like the fact that the BDC tends to avoid sectors prone to economic volatility like oil & gas, restaurants, and retail, etc.

Furthermore, their dividend coverage remains strong and their debt maturities are also well-laddered with no debt to worry about for more than a year from now, where I suspect interest rates will be much lower. Additionally, the company took advantage of the cheap valuation repurchasing a substantial amount of shares which will likely increase earnings over time.

They also announced an additional repurchase program worth $30 million which along with growing NII will likely drive NAV growth, increasing the share price over time. With a current price to NAV ratio of less than 1x and strong dividend coverage, I think BBDC has all the makings of a potential superstar in the sector, therefore warranting a buy rating.