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Near-Term Outlook Dim for SBIC & Commercial Finance Industry

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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.

Here are the three major themes in the industry:

  • Coronavirus-induced economic slowdown has resulted in a decline in commercial activities, in turn lowering the demand for small business loans. Also, lower interest rates will result in reduced investment income, and are likely to hurt SBIC & commercial finance stocks. Also, prepayments and refinancing are expected to rise, which may hamper profitability to some extent.
     
  • 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. This is expected to result in deterioration in their asset quality and cash flow strength over the next couple of quarters.
     
  • Regulatory changes are likely to work in favor of SBIC & commercial finance stocks. 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 will help 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 to offer more growth opportunities.


Zacks Industry Rank Indicates Dismal Prospects

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 #203, which places it in the bottom 20% 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. Since 2019-end, the industry’s earnings estimates for the current year have been revised 14.8% 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 29.1% over this period, the Zacks S&P 500 composite has rallied 8.8% and Zacks Finance sector has declined 15.4%.

Two-Year Price Performance

 

Industry’s 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 0.96X. This compares to the highest level of 1.16X, lowest level of 0.47X and median of 0.96X 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 11.96X, 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 3.27X is way above the Zacks SBIC & Commercial Finance industry’s ratio, as the chart below shows.

Price-to-Tangible Book Ratio (TTM)

Bottom Line

While regulatory changes will support the industry in the near term, lower interest rates and economic slowdown are likely to hurt SBIC & commercial finance stocks’ financials in the near term.

Nonetheless, one can consider investing in some stocks in the industry that depict an upbeat earnings outlook.

We are presenting one stock with a Zacks Rank #1 (Strong Buy) and four with Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 Rank stocks here.

Crescent Capital BDC, Inc. (CCAP - Free Report) : This Los Angeles, CA-based company has lost 21.9% so far this year. The Zacks Consensus Estimate for 2020 earnings has been revised 13.3% upward over the past 60 days. The stock sports a Zacks Rank of 1.

Price and Consensus: CCAP

Apollo Investment Corporation (AINV - Free Report) : This New York-based company has declined 36.4% year to date. The consensus estimate for this Zacks Rank #3 stock’s earnings for the current year has remained unchanged over the past 60 days.

Price and Consensus: AINV

Ares Capital Corporation (ARCC - Free Report) : The consensus estimate for 2020 earnings of this New York-based company has moved 15.3% upward over the past 60 days. The stock, which currently carries a Zacks Rank of 3, has lost 19.2% so far this year.

Price and Consensus: ARCC

Newtek Business Services Corp. (NEWT - Free Report) : This Boca Raton, FL-based company has decreased 20.3% year to date. The consensus estimate for 2020 earnings has been revised 12.3% upward over the past 60 days. The stock has a Zacks Rank #3.

Price and Consensus: NEWT

New Mountain Finance Corporation (NMFC - Free Report) : The consensus estimate for 2020 earnings of this New York-based company has moved nearly 1% upward over the past 60 days. The stock, which currently carries a Zacks Rank of 3, has lost 31.1% so far this year.

Price and Consensus: NMFC

 

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