Ares Capital Corporation (ARCC) Earnings & Analysis

Latest quarter

Ares Capital reported third-quarter revenue of $763.0 million, below the consensus estimate of $780.2 million. Adjusted earnings per share, as counted by the consensus, were $0.46, below the $0.48 estimate.

Revenue declined from $782.0 million a year earlier, while diluted earnings per share fell to $0.44 from $0.57. The filing attributed lower investment interest income primarily to lower base rates, which reduced the portfolio’s weighted average yield. It also attributed lower capital structuring service fees to a decrease in new investment commitments.

The company’s operating margin was 43.8%, compared with 44.6% a year earlier. Free cash flow was $1.1 billion, compared with −$773.0 million in the prior-year quarter. The filing also showed lower net investment income and a decline in the net increase in stockholders’ equity resulting from operations.

Adjusted EPS is the figure the consensus estimates, not the GAAP EPS above.

What management said on the call

CEO Kort Schnabel said volatility in interest rates, inflation and global trade lengthened merger and acquisition processes during the third quarter. He attributed the slower pace of new investment activity to those delays and Ares Capital’s selectivity, while saying the company had reviewed more transactions than a year earlier. He said market pricing, terms and lender protections remained stable.

Schnabel said some transactions were carrying into the fourth quarter. Ares Capital had closed $1.1 billion of commitments early in the quarter, and its investment backlog stood at approximately $2.5 billion. President Jim Miller said third-quarter commitments were $2.1 billion, with approximately 60.0% involving existing portfolio companies.

The company also agreed to acquire MidCap Financial Investment Corporation. Schnabel said the transaction was expected to modestly increase core earnings per share and add borrower and sponsor relationships. In response to a question about the deal’s economics, he attributed the expected increase to the acquisition discount and Ares Capital’s cost of capital. He said most of the discount was concentrated in a smaller group of investments with more uncertain outcomes.

Asked about the amount of earnings accretion, Schnabel said it would depend on strategic decisions and other considerations. He said there were too many scenarios to provide guidance around those factors. Miller said the company actively looked to extend portfolio company maturities and did not expect a specific issue from upcoming maturities.

CFO Scott Lem said the predominantly floating-rate portfolio remained sensitive to base rates and that contractual resets typically take about a quarter to flow fully into earnings. He expected some interest income benefit in the fourth quarter. Lem also said existing liquidity and a committed increase to a funding facility provided capacity to acquire the MidCap portfolio without additional debt capital.

Guidance

Ares Capital declared a fourth-quarter regular dividend of $0.48 per share, payable in December to shareholders of record in December. CFO Scott Lem said the company expected to begin seeing an interest income benefit from recent base-rate increases in the fourth quarter.