As the central bank changes its interest rate policy and the US presidential election year approaches, more volatility could await passive income investors in 2024.
With more volatility on the horizon next year, passive investors Income investors may want to prioritize high-quality BDCs with a proven track record, like Main Street Capital Company (NYSE:MAIN).
BDC delivered strong results throughout 2023 and continued to comfortably cover its dividend with net investment income last quarter.
Although Main Street Capital is still selling at an uncomfortably high premium to NAV, I think MAIN will be a great income stock for 2024.
My grade history
My last stock classification for Main Street Capital was Buy. BDC’s portfolio value reached an all-time high relative to its portfolio value at the time and my favorable view of BDC was primarily driven by Main Street Capital’s ability to grow its dividend payout.
Although MAIN is still the most expensive BDC in the industry, based on NAV premium, I believe BDC is a solid investment for passive income investors, even as markets become more volatile and unstable.
Why Main Street Capital?
Main Street Capital is an internally managed BDC that had its IPO in 2017 and has gained a reputation over time as a reliable dividend payer. Main Street Capital primarily seeks yield opportunities in the lower middle market, abandoned by financial institutions following the Great Recession of the 2000s.
Main Street Capital’s primary focus is First Liens, which is highly secure and has a protected capital position. First Liens securities represented 99% of BDC’s investments in the lower middle market portfolio. The LLM portfolio included 79 portfolio companies and was valued at $2.2 billion.
Financial performance, payout ratio, dividend growth
Main Street Capital has raced from one new portfolio value record to another over the past year and BDC’s total portfolio was valued at $4.3 billion at the end of the third quarter (including private and middle market loans).
This growth in portfolio value generated record distributable net investment income for BDC and Main Street Capital was consistently able to pass on portfolio income growth to shareholders via a growing monthly dividend.
As seen in Main Street Capital’s quarterly performance breakdown, BDC enjoyed an 18% year-over-year increase in its net distributable investment income per share in the third quarter.
The BDC benefited greatly from the central bank’s interest rate hike in 2023, resulting in robust growth in the DNII.
Main Street Capital earned $1.04 per share in distributable net investment income in 3Q-23 while distributing $0.965 per share, leading to a payout ratio of 93% (66% without the special dividend of 0.275 $ per share).
Main Street Capital increased its monthly dividend from $0.235 per share to $0.24 per share in the first quarter of 2024, resulting in a 2% dividend increase. Passive income investors can continue to expect to receive special dividends, intended to distribute excess income from their portfolio.
In 2023, Main Street Capital paid a total of $0.95 per share. The yield based on the regular monthly dividend currently stands at 6.7%. Including a special dividend equivalent to $0.95 per share, Main Street Capital is expected to generate an effective yield of 8.9%.
Main Street Capital: still the most expensive BDC in the sector
Main Street Capitals’ 9% dividend is valued at a 52% premium to NAV, making BDC, to my knowledge, the most expensive BDC stock among passive income investors can buy.
Income investors have long questioned whether or not this premium is justified, particularly because many other BDCs offer comparable or higher yields at much lower liquidation valuations.
That being said, the value of an investment in Main Street Capital comes with the implicit assurance that BDC will continue to increase its monthly dividend (and pay special quarterly dividends to distribute additional portfolio income). I think the 52% premium to NAV is justified, especially since the dividend will likely grow in 2024.
Although other BDCs trade at NAV, or at least lower premiums, Main Street Capital is ultimately the BDC that sleeps well and puts dividend growth on autopilot.
Low interest rate environment, other headwinds for Main Street Capital
The central bank updated its interest rate policy in December and indicated it would pursue up to three rate cuts in 2024, which could lead to increased market volatility next year. 2024 will also be a presidential election year in the United States, which could also introduce some wild cards to the markets.
However, when it comes to dividend quality and stability, I have no reservations with Main Street Capital.
As 2023 draws to a close, a major interest rate policy change has been announced, and a presidential election year approaches, I believe passive income investors will be able to weather any form of increased market volatility by investing in Main Street Capital.
BDC’s dividend may not be cheap, and the extent to which the large NAV premium is justified is up for debate, but I think passive income investors can do nothing wrong by holding Main Street Capital in 2024.
BDCs with a proven track record and record distributable net investment income are, in my opinion, solid investments for passive income investors, and the dividend and yield are expected to see continued growth in 2024.