The Zacks SBIC & Commercial Finance industry will benefit from a rise in demand for personalized financing solutions amid economic resilience. A decent rise in refinancing activity is expected, which will support the industry players’ total investment income. The industry will also continue to benefit from favorable regulatory changes.
However, gradual deterioration in asset quality because of prolonged high rates is a headwind and might hurt industry players’ financials in the coming days. Nonetheless, a few players like Main Street Capital Corporation MAIN, Barings BDC, Inc. BBDC and Crescent Capital BDC, Inc. CCAP are worth betting on.
About the Industry
The Zacks SBIC & Commercial Finance industry comprises companies that provide finance to small and mid-sized privately held developing firms. These firms are typically underserved by traditional banks and other lenders. Additionally, firms suffering from financial distress are the primary target clients of these lenders. The industry players provide customized financing solutions, ranging from senior debt instruments to equity capital. This financing is provided for a change of ownership transactions, buyouts, recapitalizations and growth initiatives in partnership with business owners, management teams and financial sponsors, among others. Some of the other products offered by the industry participants are mezzanine loans that typically pay high interest rates and can be converted into equity in the target firm.
3 Key Themes of the SBIC & Commercial Finance Industry
Relatively Low Rates & Economic Strength: The Federal Reserve lowered the interest rates by 100 basis points last year and is likely to cut rates twice this year. As the interest rates gradually come down, demand for products and services offered by SBIC & Commercial Finance industry players is likely to improve. Further, solid economic growth and gradually cooling inflation numbers are expected to drive the demand. Thus, the rise in transaction activity will support total investment income growth for these companies.
Further, relatively lower rates are expected to result in a spike in refinancing amid increased competition. So, the industry players will benefit from this.
Regulatory Changes: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helped these companies reduce portfolio risks by investing in higher capital structures without forgoing current returns. Thus, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Asset Quality: Following the COVID-19 outbreak and a subsequent halt in business activities in 2020, most sectors wherein SBIC & Commercial Finance companies provide finance were hit hard. This raised fears of a deterioration of asset quality for industry players. Nonetheless, support from the administration in the form of stimulus packages and the subsequent re-opening of businesses supported economic growth. This, thus, prevented a substantial rise in delinquency rates for the industry players.
However, with prolonged higher interest rates, industry players are likely to witness some weakness in asset quality as the portfolio companies might find it difficult to service debt. Also, heightened geopolitical risk will put a strain on SBIC & Commercial Finance companies’ asset quality.
Zacks Industry Rank Indicates Robust Prospects
The Zacks SBIC & Commercial Finance industry is a 34-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #42, which places it in the top 17% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a encouraging earnings outlook for the constituent companies in aggregate. Looking at aggregate earnings estimate revisions, it seems that analysts are gradually gaining confidence in this group’s bottom-line growth potential.
Before we present a few stocks that are well-positioned to outperform the market, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Underperforms the Sector and the S&P 500
The Zacks SBIC & Commercial Finance industry has underperformed the S&P 500 composite and its sector over the past two years.
The stocks in this industry have collectively risen 17.8% over this period, while the Zacks S&P 500 composite and the Zacks Finance sector have rallied 48.5% and 35.6%, respectively.
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/TB), which is commonly used for valuing loan providers because of large variations in their earnings from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 1.03X. The highest level of 1.05X, the lowest of 0.42X and a median of 0.92X have been recorded by the industry over the past five years. Also, the industry is trading at a significant discount compared with the market at large, as evidenced by the trailing 12-month P/TB for the S&P 500 composite of 17.24X, 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. Hence, comparing the group’s P/TB ratio with its broader sector ensures that the group is trading at a solid discount. The Zacks Finance sector’s trailing 12-month P/TB of 5.56X is also way above the Zacks SBIC & Commercial Finance industry’s ratio, as shown below.
Price-to-Tangible Book Ratio (TTM)
3 SBIC & Commercial Finance Stocks to Buy
Main Street Capital: This Zacks Rank #2 (Buy) private equity firm specializes in providing equity capital to lower-middle-market (LMM) companies. Main Street Capital also offers debt capital to middle-market companies. Based in Houston, TX, MAIN invests in LMM companies that generate annual revenues between $10 million and $150 million.
As of Sept. 30, 2024, Main Street Capital had total investments (fair value) of $4.53 billion in 193 portfolio companies, which consisted of investments in the LMM portfolio, the middle-market portfolio and the private loan portfolio. As of the same date, MAIN’s net asset value (NAV) was $30.57 per share.
At the end of the September quarter, Main Street Capital had total liquidity of $1.33 billion, which included $84.4 million in cash and cash equivalents and $1.25 billion of unused capacity under its revolving credit facility. As of Sept. 30, 2024, MAIN had a total debt worth $2.2 billion, consisting of debentures and senior notes.
Main Street Capital has a market cap of $5.4 billion. Over the past six months, MAIN’s stock has rallied 23.6%. The Zacks Consensus Estimate for earnings has remained unchanged at $4.11 for 2024 and has been revised 1.2% upward to $4.06 for 2025 over the past 30 days.
Price and Consensus: MAIN
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. This Zacks Rank #1 (Strong Buy) company also has investments in middle-market companies located outside the country. You can see the complete list of today’s Zacks #1 Rank stocks here.
As of Sept. 30, 2024, Barings BDC had total investments (fair value) of 2.42 billion and NAV per share of $11.32. Further, at September 2024-end, BBDC had $1.37 billion of total debt outstanding. This is significantly higher than cash and foreign currencies of $66 million as of the same date.
Over the years, this Charlotte, NC-based company has grown through acquisitions. Some of the notable ones are MVC Capital, Inc. and Sierra Income Corporation. These have helped bolster its market share over time.
The company’s shares have gained 3.6% over the past six months. The Zacks Consensus Estimate for earnings has remained unchanged at $1.24 for 2024 and has been revised 2.7% upward for 2025 over the past 30 days. BBDC has a market cap of $1.09 billion.
Price and Consensus: BBDC
Crescent Capital: This is a specialty finance company mainly focused on originating and investing in the debt of private middle market companies principally located in the United States. Carrying a Zacks Rank #2, CCAP offers capital solutions to companies with sound business fundamentals and strong growth prospects.
As of Sept. 30, 2024, Crescent Capital had total investments (fair value) of $1.59 billion (in 183 portfolio companies). Of the total investment value, 64.4% was Unitranche first lien. As of the same date, NAV was $20.20 per share.
Los Angeles, CA-based company had a debt of $857.3 million. It had $37.8 million in cash and cash equivalents, and restricted cash and $317 million of undrawn capacity on its credit facilities.
Crescent Capital has a market cap of $739.9 million. Over the past six months, the company’s shares have risen 10.8%. Over the past 30 days, the Zacks Consensus Estimate for 2024 earnings has remained unchanged at $2.43 and moved almost 1% north to $2.09 for 2025.
Price and Consensus: CCAP
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