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SBIC & Commercial Finance Industry Outlook: Prospects Look Good

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Rising consumer confidence, lower unemployment rate and lesser tax rates will likely drive the performance of SBIC & commercial finance stocks. These stocks mainly invest in debt and equity of small and mid-sized privately held developing companies. Steadily improving U.S. economy and robust economic data are expected to lead to rise in demand for such loans.

Moreover, regulatory changes are expected to work in favor for SBIC & commercial finance stocks. In March 2018, an amendment in the Investment Company Act of 1940 by the Small Business Credit Availability Act eased the leverage limits for such companies. This allows these companies to increase their debt-to-equity leverage to 2:1 from the present 1:1.

Easing of leverage restriction will allow SBIC & commercial finance stocks to lower their portfolio risk by investing in higher capital structures without having to forego current returns. In other words, it will give extra funding flexibility to these companies and provide more growth opportunities.

While higher interest rates are helping SBIC & commercial finance stocks to earn better investment income, they are making borrowing expensive. So, the net benefit is not significant.

Nonetheless, the industry’s near-term prospects look good given the continued rise in demand for small business loans. Also, as SBIC & commercial finance companies are required to distribute majority of their net investment income and capital gains annually, shares of these companies are usually attractive to income investors.

Industry Lags on Shareholder Returns

Looking at shareholder returns over the past two years, it appears that the border economic recovery wasn’t enough for enhancing investors’ confidence in the industry’s growth prospects. But regulatory and policy changes, and acceleration of economic growth should be encouraging enough for investors to bet on this space now.

The Zacks SBIC & Commercial Finance Industry, which is part of the broader Zacks Finance Sector, has underperformed both the S&P 500 and its own sector over the past two years.

While the stocks in this industry have collectively gained just 4.5%, the Zacks S&P 500 Composite and Zacks Finance Sector have rallied 32.2% and 24.8%, respectively.

Two-Year Price Performance

 

SBIC & Commercial Finance Stocks Look Inexpensive

Thanks to the underperformance over the past two years, the industry’s valuation looks reasonable now. 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 the most appropriate multiple for valuing SBIC &commercial loan providers because of large variations in their earnings results from one quarter to the next. 

This ratio essentially measures a company’s current market value relative to what it would be worth if all assets were sold, debt was paid and intangible assets were written off.

The industry currently has a trailing 12-month P/TBV ratio of 1.01X, which is slightly above the median level of 0.97X over the past two years. When compared with the highest level of 1.07X over this period, it is obvious that the group's valuation level was higher earlier.

The industry has traded at a discount to the broader market and that's the case at present as well, as the chart below shows.
 

Price-to-Tangible Book Ratio (TTM)

As finance stocks typically have a lower P/TBV ratio, comparing SBIC & commercial finance stocks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of its broader sector also ensures that the group is trading at a decent discount. The Zacks Finance Sector’s trailing 12-month P/TBV ratio of 3.70X and the two-year median level of 3.52X for the same period are above the Zacks SBIC & Commercial Finance Industry’s respective ratios.

Price-to-Tangible Book Ratio (TTM)


Relatively Stable Earnings Outlook Indicates Decent Prospects

Expectations of improving profitability with rising interest rates, improving economy and other strategic and regulatory initiatives should help SBIC & commercial finance stocks generate positive shareholder returns in the near future.

But what really matters to investors is whether this group has the potential to outperform the broader market in the quarters ahead. Investors may consider the current price levels as good entry points, as there are convincing reasons to predict a decent upside in the near term.

One reliable measure that can help investors understand the industry’s prospects going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, which is a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks SBIC & Commercial Finance Industry


This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $1.16 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks SBIC & Commercial Finance industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $1.16 per share for 2018, but how this dollar number has evolved recently.

Current Year EPS Estimate Revisions

As you can see here, the $1.16 EPS estimate for 2018 is up from $1.15 at the end of April and at the end of the month prior to that. Also, the figure is stable year over year.

Zacks Industry Rank Indicates Bright Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks SBIC & Commercial Finance industry currently carries a Zacks Industry Rank #80, which places it at the top 31% of more than 250 Zacks industries. 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.

Our proprietary Heat Map shows that the industry’s rank has remained in the top half of the rank list over the past eight weeks except just once.
 


Long-Term Growth Prospects Don’t Look Impressive

While the near-term prospects look decent, long-term (3-5 years) EPS growth estimates for the Zacks SBIC & Commercial Finance industry don’t seem impressive. The group’s mean estimate of long-term EPS growth rate has decreased since the beginning of 2018 and has remained stable of late at 3.63%. This also compares unfavorably with 9.82% earnings growth rate for the Zacks S&P 500 Composite.
 

Mean Estimate of Long-Term EPS Growth Rate

Since mid-2016, revenues have been steadily improving. This is mainly driven by rising interest rates and economic improvement. 


Bottom Line

SBIC & commercial finance stocks will likely continue benefiting from higher interest rates, regulatory changes, lower tax rates and strong economy in the near term. So, investing in this space could be rewarding.

One should particularly consider betting on the SBIC & commercial finance stocks that reflect an improving earnings outlook.

5 SBIC & Commercial Finance Stocks to Bet on

THL Credit, Inc. (TCRD - Free Report) : The stock of this Boston-based company has risen 1.9% over the past six months. The Zacks Consensus Estimate for the current-year EPS has been revised 5.5% upward over the last 60 days. The stock currently sports Zacks Rank #1 (Strong Buy). (You can see the complete list of today’s Zacks #1 Rank stocks here.)

Price and Consensus: TCRD


TriplePoint Venture Growth BDC Corp. (TPVG - Free Report) : The consensus EPS estimate for this Menlo Park, CA-based company has moved 13.8% higher for the current year, over the last 60 days. This Zacks Rank #1 stock has rallied 15.1% over the past six months.

Price and Consensus: TPVG


Saratoga Investment Corp. (SAR - Free Report) : The stock of New York-based company has gained 11.6% over the past six months. The consensus EPS estimate for the current year has been revised 2.2% upward over the last 60 days. The stock carries a Zacks Rank 2 (Buy).
 

Price and Consensus: SAR

 

OFS Capital Corporation (OFS - Free Report) : The consensus EPS estimate for this Chicago, IL-based company has moved 1.6% upward for the current year, over the last 60 days. This Zacks Rank #2 stock has rallied 9.5% over the past six months.
 

Price and Consensus: OFS


Newtek Business Services Corp. (NEWT - Free Report) : The consensus EPS estimate for this Lake Success, NY-based company has moved 1.6% higher for the current year, over the last 60 days. This Zacks Rank #2 stock has surged 38.7% over the past six months.
 

Price and Consensus: NEWT

 

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