Main Street Capital: Energy Bites Its Dividend Income

On its conference call, Main Street Capital (MAIN -0.51%) executives fielded an odd number of questions about the company's dividend income from its portfolio of small businesses. What were analysts so interested in? I had to take a look for myself.

Start from the top
Main Street Capital makes money for shareholders by making loans to, and buying pieces of, small businesses in the United States. It primarily invests in companies that are controlled by others, though it has a hearty portfolio of smaller businesses it does control (defined as businesses in which it owns more than 25% of the equity). Think things like jewelry stores, restaurants, and RV dealers.

The company breaks out its earnings from its portfolio companies into three sources -- interest, dividends, and fees. Primarily a lender, roughly 80% of its income came in the form of interest in 2015. Dividends made up about 15% of its income, and fees tallied up to the other 5%.

Though seemingly unimportant at just 15% of its investment income, the dividends Main Street Capital receives from the companies it invests are seen as something of a barometer for the health of its underlying investments. Logic follows that the combined earnings power of its portfolio companies should be measurable with the dividends they collectively pay back to Main Street Capital.

Unfortunately, dividends from small businesses can be pretty lumpy. The fourth quarter is when most of the haul comes in, and when the fruits of a full year can be tallied. Calendar year 2015 wasn't exactly a groundbreaker, getting little in the way of a seasonal quarterly boost. Main Street Capital took in about $6.9 million in dividend income during Q4 2015 vs. $6.8 million in the prior year.

Main Street executives pitched the case that the fourth quarter of 2014 was particularly good for dividend income, and suggested that dividend income actually grew by about $600,000 if you ignore about $700,000 of 2014 dividends that were "unusual."

Some other "noise" in this income item occurs due to the fact that its portfolio companies aren't paying out all of their free cash in the form of dividends. Some naturally gets reinvested. Some likely gets stored away for a rainy day. 

Taken in the aggregate, however, we can clearly see that after robust growth from 2013 to 2014, dividend income from its portfolio companies slowed in 2015.

Looking under the hood
Only by doing a deeper dive into its tables of transactions with portfolio companies can we see the changes in dividend income on an individual-company basis. In comparing its 2015 filings to its 2014 filings, I found four particularly noteworthy investments that paid substantially lower dividends back to Main Street Capital this year.

The first is Mid-Columbia Lumber, which paid a $1.24 million dividend in 2014 only to pay -$34,000 in dividends in 2015. I have no explanation for the negative figure, but do note that the reduction in dividends does seem to be the result of a significant change to its business. Main Street Capital wrote down the value of its equity investment in the company by $7.6 million, or nearly 75% of its value at the beginning of the year.

Three energy-exposed industrial companies, Gulf Manufacturing, L.F. Manufacturing, and Houston Plating and Coating, seem to have been negatively affected by the downturn in oil prices. This group paid just $913,000 in dividends to Main Street in 2015 vs. $3.2 million in 2014. Its equity investments in the companies were written down by nearly $6.7 million, or 22% of their value at the beginning of 2015. Importantly, these companies are not classified as part of the 9.4% of its portfolio dedicated to energy pure-plays at the end of 2015.

There are, of course, some offsetting investments. Perennial winner CBT Nuggets paid a $4.77 million dividend back to Main Street, up from $3.76 million last year. Meanwhile, Main Street's asset management arm kicked in nearly $2.2 million in dividends compared to less than a half million dollars in 2014.

But all in all, the slowing growth in dividends from portfolio companies was a little disappointing to see. Main Street Capital carried its equity investments at a valuation of about $531 million vs. $408 million last year. Should dividend income continue to come in soft, companies that have been written up will likely need to take a ride back down.