EC Saratoga CFO: Healthy Dividend, Lots Of Dry Powder

After speaking with the Chief Financial Officer (Henri Steenkamp) of Saratoga Investment Corp. for 40 minutes earlier this week, our main takeaway is that the 9.2% dividend yield of this small cap Business Development Company (BDC) is healthy (with room to grow) because the company continues to enjoy an attractive valuation (even after the shares strong rally so far this year), several important competitive advantages (for example, access to plenty of low-cost capital, aka “dry powder”), and may actually be less impacted by some of the big risks facing the BDC industry as a whole.

Overview:

Saratoga Investment Corp (SAR) is a publicly traded BDC providing financing solutions to lower middle market companies through its SBIC-licensed subsidiary and a $300 million Collateralized Loan Obligation (CLO) fund. As the following chart shows, Saratoga’s portfolio is composed mainly of first and second liens, and the yields on these financing arrangements are significant (this is how Saratoga supports its healthy dividend).

And for reference, Saratoga’s investments are diversified geographically and across industries as shown in the following charts.

Dividend History:
Understanding the recent evolution of Saratoga’s dividend is helpful in gauging its prospects going forward. For starters, when Saratoga first took over the BDC in 2010, the company was in distress, and management’s focus was on preserving capital. Saratoga was eventually able to offer a dividend that was paid 80% in stock and only 20% in cash. In 2014, Saratoga was able to move to a 100% cash dividend with the option of a dividend reinvestment program (DRIP) whereby the dividend could be used to purchase more shares at a discount to their market price (note: the market price is also trading at a discount to NAV, more on this discount later). The dividend has since then continued to grow (see chart below), plus Saratoga has recently paid an additional supplemental dividend of $0.20 (because they had extra income above and beyond the normal dividend amount). 

The relatively large supplemental dividend is a testament to the strength of Saratoga’s business, its conservative dividend policy, and a signal of more potential dividend increases ahead. For reference, this next chart shows Saratoga’s strong dividend coverage ratio relative to other BDCs.

Valuation:

From a valuation standpoint, Saratoga currently trades at a discount to its net asset value (NAV). For some perspective, the following table includes Saratoga’s price-to-book ratio (+0.9) relative to other BDCs.