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3 SBIC & Commercial Finance Stocks to Gain Amid Lower Rates, Slowdown
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The Zacks SBIC & Commercial Finance industry is bearing the brunt of a low interest rate environment and coronavirus-induced economic slowdown. This is, thus, leading to subdued demand for business loans. Also, credit costs and delinquency rates are likely to rise, resulting in worsening of asset quality.
Nevertheless, regulatory changes and gradual reopening of the economy are expected to support the industry in the near term. Thus, some of the industry players like Golub Capital BDC, Inc. (GBDC - Free Report) , Barings BDC, Inc. (BBDC - Free Report) and Saratoga Investment Corp. (SAR - Free Report) are set to benefit from these developments.
Industry Description
The Zacks SBIC & Commercial Finance industry consists of companies that provide finance to small and mid-sized privately-held developing firms, which are generally underserved by traditional banks and other lenders. Firms suffering from financial distress are the primary target clients of these lenders.
Products offered by the industry participants also include mezzanine loans that typically pay high interest rates and could be converted into equity in the target firm.
3 SBIC & Commercial Finance Industry Trends to Keep an Eye on
Economic Slowdown & Low Rates Weigh on Performance: Coronavirus-induced economic slowdown has resulted in a decline in commercial activities, in turn, lowering the demand for business loans. Also, near-zero interest rates are expected to result in reduced investment income, and are likely to hurt SBIC & Commercial Finance stocks’ top-line growth. Further, a spike in prepayments and refinancing is expected to hamper profitability to some extent.
Deteriorating Asset Quality is a Concern: Given the virus outbreak and subsequent halt in business activities, the majority of sectors wherein SBIC & commercial finance companies provide loans have been hit hardest. While there is a gradual revival in business activities, the industry players are expected to record uptick in non-accruals. This is expected to lead to worsening of asset quality and decline in cash flow strength over the next few quarters.
Regulatory Changes Offer Some Support: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased the leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helps these companies to reduce portfolio risk by investing in higher capital structures without foregoing current returns. In other words, the act has provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Zacks Industry Rank Indicates Near-Term Grim Picture
The Zacks SBIC & Commercial Finance industry is a 35-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #167, which places it at the bottom 34% 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 outperforms 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 disappointing earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s bottom-line growth potential. Over the past year, the industry’s earnings estimates for the current year have been revised 12.7% downward.
Despite disappointing near-term prospects, we are presenting a few stocks that are well positioned to outperform the market based on a strong earnings outlook. Before doing this, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks SBIC & Commercial Finance industry has underperformed both the S&P 500 composite and its own sector over the past two years.
While the stocks in this industry have collectively lost 20.6% over this period, the Zacks S&P 500 composite has rallied 25.8% and Zacks Finance sector has declined 5.2%.
Two-Year Price Performance
Industry’s Current 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 results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.73X. This compares to the highest level of 1.07X, lowest level of 0.39X and median of 0.94X over the past five years. Additionally, the industry is trading at a significant discount compared with the market at large, as is evident from the trailing 12-month P/TB for the S&P 500 composite of 15.63X, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
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. But a comparison of the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TB of 3.36X is way above the Zacks SBIC & Commercial Finance industry’s ratio, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
3 SBIC & Commercial Finance Stocks Worth Betting on
Golub Capital BDC: This Zacks Rank #2 (Buy) stock makes investments mainly in one stop (a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans) and other senior secured loans of middle-market companies. Based in New York, the company invests roughly $10-$75 million of capital.
Following the acquisition of Golub Capital Investment Corporation in September 2019, Golub Capital become the fifth largest externally managed, publicly traded business development company, in terms of assets. The deal continues to support the company’s financials.
Its shares have rallied 26.8% over the past six months. The Zacks Consensus Estimate for earnings has remained unchanged at $1.21 and $1.10 for fiscal 2020 and fiscal 2021, respectively, over the past 30 days.
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. It also has investments in middle-market companies located outside the country.
This Charlotte, NC-based company, in August, entered into a definitive merger agreement under which MVC Capital will merge with and into Barings BDC. The stock-cum-cash deal, expected to close later this quarter, will likely to accretive to net investment income in the first full quarter post-closure and generate cost synergies over time.
The Zacks Consensus Estimate for 2020 earnings has remained unchanged at 59 cents over the past month. The consensus estimate for 2021 earnings of 66 cents has been revised 4.8% upward over the same time frame.
The stock carries a Zacks Rank #2, presently. Shares of the company have risen 29% over the past six months.
Price and Consensus: BBDC
Saratoga Investment: Headquartered in New York, the company invests in senior and unitranche leveraged loans and mezzanine debt and, to some extent, equity issued by private U.S.-based middle-market companies. As of Aug 31, 2020, it had total assets worth $578.8 million and investments in 40 portfolio companies.
Shares of this Zacks Rank #2 company have surged 48.1% over the past six months. The Zacks Consensus Estimate for fiscal 2021 earnings has moved 3.4% up to $2.12 over the past 30 days. Likewise, the same for fiscal 2022 has been revised 1.5% upward to $2.04 over the past month.
Price and Consensus: SAR
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3 SBIC & Commercial Finance Stocks to Gain Amid Lower Rates, Slowdown
The Zacks SBIC & Commercial Finance industry is bearing the brunt of a low interest rate environment and coronavirus-induced economic slowdown. This is, thus, leading to subdued demand for business loans. Also, credit costs and delinquency rates are likely to rise, resulting in worsening of asset quality.
Nevertheless, regulatory changes and gradual reopening of the economy are expected to support the industry in the near term. Thus, some of the industry players like Golub Capital BDC, Inc. (GBDC - Free Report) , Barings BDC, Inc. (BBDC - Free Report) and Saratoga Investment Corp. (SAR - Free Report) are set to benefit from these developments.
Industry Description
The Zacks SBIC & Commercial Finance industry consists of companies that provide finance to small and mid-sized privately-held developing firms, which are generally underserved by traditional banks and other lenders. Firms suffering from financial distress are the primary target clients of these lenders.
Products offered by the industry participants also include mezzanine loans that typically pay high interest rates and could be converted into equity in the target firm.
3 SBIC & Commercial Finance Industry Trends to Keep an Eye on
Economic Slowdown & Low Rates Weigh on Performance: Coronavirus-induced economic slowdown has resulted in a decline in commercial activities, in turn, lowering the demand for business loans. Also, near-zero interest rates are expected to result in reduced investment income, and are likely to hurt SBIC & Commercial Finance stocks’ top-line growth. Further, a spike in prepayments and refinancing is expected to hamper profitability to some extent.
Deteriorating Asset Quality is a Concern: Given the virus outbreak and subsequent halt in business activities, the majority of sectors wherein SBIC & commercial finance companies provide loans have been hit hardest. While there is a gradual revival in business activities, the industry players are expected to record uptick in non-accruals. This is expected to lead to worsening of asset quality and decline in cash flow strength over the next few quarters.
Regulatory Changes Offer Some Support: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased the leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helps these companies to reduce portfolio risk by investing in higher capital structures without foregoing current returns. In other words, the act has provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Zacks Industry Rank Indicates Near-Term Grim Picture
The Zacks SBIC & Commercial Finance industry is a 35-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #167, which places it at the bottom 34% 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 outperforms 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 disappointing earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s bottom-line growth potential. Over the past year, the industry’s earnings estimates for the current year have been revised 12.7% downward.
Despite disappointing near-term prospects, we are presenting a few stocks that are well positioned to outperform the market based on a strong earnings outlook. Before doing this, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks SBIC & Commercial Finance industry has underperformed both the S&P 500 composite and its own sector over the past two years.
While the stocks in this industry have collectively lost 20.6% over this period, the Zacks S&P 500 composite has rallied 25.8% and Zacks Finance sector has declined 5.2%.
Two-Year Price Performance
Industry’s Current 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 results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.73X. This compares to the highest level of 1.07X, lowest level of 0.39X and median of 0.94X over the past five years. Additionally, the industry is trading at a significant discount compared with the market at large, as is evident from the trailing 12-month P/TB for the S&P 500 composite of 15.63X, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
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. But a comparison of the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TB of 3.36X is way above the Zacks SBIC & Commercial Finance industry’s ratio, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
3 SBIC & Commercial Finance Stocks Worth Betting on
Golub Capital BDC: This Zacks Rank #2 (Buy) stock makes investments mainly in one stop (a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans) and other senior secured loans of middle-market companies. Based in New York, the company invests roughly $10-$75 million of capital.
Following the acquisition of Golub Capital Investment Corporation in September 2019, Golub Capital become the fifth largest externally managed, publicly traded business development company, in terms of assets. The deal continues to support the company’s financials.
Its shares have rallied 26.8% over the past six months. The Zacks Consensus Estimate for earnings has remained unchanged at $1.21 and $1.10 for fiscal 2020 and fiscal 2021, respectively, over the past 30 days.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: GBDC
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. It also has investments in middle-market companies located outside the country.
This Charlotte, NC-based company, in August, entered into a definitive merger agreement under which MVC Capital will merge with and into Barings BDC. The stock-cum-cash deal, expected to close later this quarter, will likely to accretive to net investment income in the first full quarter post-closure and generate cost synergies over time.
The Zacks Consensus Estimate for 2020 earnings has remained unchanged at 59 cents over the past month. The consensus estimate for 2021 earnings of 66 cents has been revised 4.8% upward over the same time frame.
The stock carries a Zacks Rank #2, presently. Shares of the company have risen 29% over the past six months.
Price and Consensus: BBDC
Saratoga Investment: Headquartered in New York, the company invests in senior and unitranche leveraged loans and mezzanine debt and, to some extent, equity issued by private U.S.-based middle-market companies. As of Aug 31, 2020, it had total assets worth $578.8 million and investments in 40 portfolio companies.
Shares of this Zacks Rank #2 company have surged 48.1% over the past six months. The Zacks Consensus Estimate for fiscal 2021 earnings has moved 3.4% up to $2.12 over the past 30 days. Likewise, the same for fiscal 2022 has been revised 1.5% upward to $2.04 over the past month.
Price and Consensus: SAR
Breakout Biotech Stocks with Triple-Digit Profit Potential
The biotech sector is projected to surge beyond $775 billion by 2024 as scientists develop treatments for thousands of diseases. They’re also finding ways to edit the human genome to literally erase our vulnerability to these diseases.
Zacks has just released Century of Biology: 7 Biotech Stocks to Buy Right Now to help investors profit from 7 stocks poised for outperformance. Our recent biotech recommendations have produced gains of +50%, +83% and +164% in as little as 2 months. The stocks in this report could perform even better.
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