Main Street: Too Expensive To Touch, But Bonds Look Delicious (NYSE:MAIN)

On our last coverage of Main Street Capital (NYSE:MAIN) we felt the valuation was middling for the shares. We expected the premium performance to continue, but just couldn’t get behind it at the valuation at the time. On the other hand we found solid appeal in the bonds and gave them a buy rating. We now look at how those trades have worked and how the company has fared. We also give a new suggestion for income seekers.

The Company

MAIN is one of the best known BDCs and it has provided capital to the private markets since 2007. Its focus on the lower-middle markets means that the average company EBITDA size is lower than what you will find for Blue Owl Capital Corporation (OBDC) or Blackstone Secured Lending Fund (BXSL).

But that is an area where MAIN’s expertise has been built and it continues to shine with little competition. The results speak for themselves and the dividend growth plus NAV growth has been a splendid story for the last 17 years.

2023 was particularly impressive as total investment income went up by 33%, thanks to those rate hikes the Federal Reserve put in. MAIN’s debt costs were less sensitive on a relative basis and distributable income went vertical.

Our Previous Take

We had rated MAIN as neutral and suggested its bonds would offer solid income support for those wanting a very safe yield. While the latter part worked out with excellent total returns for those bonds, MAIN’s stock was an absolute monster and did phenomenally well. It was an error to stay out. But do we change things today and go in?

Current Setup

One of the reasons MAIN has rallied so much is that the whole BDC sector is getting a second wind from the “higher for longer” thesis. We actually have always been onboard with this and have thrown cold water on the idea that Federal Reserve will cut rapidly. But alongside benefiting from that high interest rate environment, MAIN has managed to do something that some of the other BDCs are struggling with. It has managed to keep a lid on its non-accruals. In the last presentation that had non-accruals at just 0.6% of the total portfolio at fair value.

How does that compare? Well, we don’t want to throw in the entire BDC Universe in here as that just complicates things. But let us look at two BDCs that are moving at the other end of the spectrum. First up, FS KKR Capital Corp (FSK). This is quite popular with the investment crowd on Seeking Alpha. The current non-accrual rate is at 5.5% of portfolio fair value. That is about nine times higher than where MAIN is currently sitting.

Oaktree Specialty Lending Corporation (OCSL), the BDC run by the famous Howard Marks outfit, was sporting 4.2% in non-accruals. Here the number is stated as a percentage of debt portfolio. OCSL also has equity investments and as a percentage of total portfolio, this number is a bit lower.

These two and one more were currently given a stern warning from Moody’s (MCO).

What To Buy

So MAIN is really differentiating itself from the pack and its outperformance of OCSL is quite impressive. But here is the thing. The price is definitely reflecting this. While FSK rightly trades at a 20% discount to NAV and OCSL is near its NAV, MAIN is trading at a 63% premium above NAV.

A similar thing can be seen in the dividend yield. MAIN has to outperform by 8% a year just to compensate for the dividend advantage offered by FSK.

All of this may work out for MAIN as it has historically done, but paying such a premium at this stage of the cycle seems dangerous. So what can we do? Well fortunately for investors, you have a chance to grab some pure alpha in another area.

While the equities reflect the current situation, the bonds do not.

MAIN’s 2029 bond (CUSIP and Symbol below) are now trading at 6.81% yield to maturity. They also have a very high coupon (6.95%) so you are getting immediate income without having to rely on capital gains.

The alpha here comes from being able to pick up the highest quality and lowest risk bonds, without giving much yield. Actually when you compare to OCSL’s bonds maturing at almost exactly the same time, you pick up 2 basis points based on the last close.

But considering the credit warning, one should be inclined to demand at least 50 basis points higher in yield to maturity for OCSL relative to the number one performer in the BDC space. We can make a similar argument for FSK.

So the alpha here is grabbing the MAIN bonds. They are investment grade like the other two (and most BDC bonds) and also offer a superior yield relative to iShares 5-10 Year Investment Grade Corporate Bond ETF (IGIB). With that investment grade fund, you are getting about 5.65% after expenses.

Whichever way you look at it, MAIN bonds offer compelling value for yield investors. They might not be for investors who think multiple rate cuts are on the way though. In that case you might do better with longer duration bonds. We don’t fall in that camp and think the long end blowing up is more probable.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.