Main Street Capital (MAIN 0.88%) is beloved for its historical underwriting performance, which has translated into industry-leading stock returns for its investors. Shares now trade at a 73% premium to book value, whereas the median company in its industry trades at a 5% discount to book.
Given its sky-high book value multiple, investors should remain focused on the risks that threaten its high valuation. If Main Street Capital were to trade down to the valuation of the second highest-valued business-development company (Hercules Capital at 1.37 times book), investors would stand to lose nearly three years of dividends to capital losses.
With this in mind, it's prudent to keep an eye on what could potentially rattle Main Street Capital's underlying business, and its share price. Here are three things worth studying carefully when Main Street Capital reports earnings on Aug. 3, and for the remainder of the year.
Energy exposure
Much has been said about Main Street Capital's oil and gas exposure. Direct exposure -- companies categorized as "energy equipment and services" and "oil, gas, and consumable fuels" businesses -- tallies to approximately $2.49 of book value per Main Street Capital share (11% of book value).
That's the knowable risk that is clear from its disclosures. Indirect exposure is the unknowable factor. Many businesses in its portfolio have exposure to energy, even though they aren't energy companies themselves.
For example, Main Street Capital invests in Datacom LLC, which is labeled as a "technology and telecommunications provider" in its filings, so it is not included in the tally of oil and gas-related investments. That said, because many of Datacom's customers are oil businesses, it has taken a hit as oil prices decline.
|
Quarterly Period |
Datacom Cost |
Datacom Fair Value |
Fair Value as % of Cost |
|---|---|---|---|
|
Q1 2015 |
$17.1 million |
$17.1 million |
100% |
|
Q1 2016 |
$18.4 million |
$16.6 million |
90% |
|
Q1 2017 |
$20.1 million |
$15.9 million |
79% |
Datacom's value declined with the oil bust. Data source: SEC filings.
Based in Houston, Main Street Capital has investments in many Texas-based companies whose profitability ebbs and flows with the local economy. It goes without saying that oil remains a negative factor for Main Street Capital, given low prices have knock-on effects to businesses that have no direct links to oil. Houston lost more than 81,000 high-paying energy jobs during the downturn, and data from the Bureau of Labor Statistics show job growth remained positive due to a surge in lower-paying hospitality careers.
Image source: Getty Images.
Retail risks
Main Street Capital's stressed retail investments make up approximately 3% of its last-reported net asset value (book value) and could be the source of further writedowns when the company reports earnings for the second quarter.
For some in this group, losses appear certain -- if not now, then later.
|
Company Name |
Fair Value vs. Cost |
Notes |
|---|---|---|
|
Bluestem Brands |
84% |
S&P downgrade on July 10; parent company stock is down 37% year to date. |
|
Charlotte Russe |
65% |
S&P and Moody's downgrade to CCC+ and Caa1 on Feb. 6 and May 25, respectively. |
|
Guitar Center |
88% |
Talk of possible restructuring. Moody's negative on April 12. |
|
TOMS Shoes |
72% |
Moody's downgrade on July 17. |
Data source: Fair value vs. cost calculated from Main Street Capital filings. Notes by author, sourced from ratings agency releases.
On a per-share basis, these investments make up approximately $0.64 of book value, which last stood at $22.44 per share at March 31, 2017.
Main Street Capital has additional retail exposure, most notably its investment in Jensen Jewelers, which is worth approximately $0.15 per Main Street Capital share. There is little public data about the Jensen investment, given that it's a small Idaho-based jewelry chain. What we do know, however, is that Jensen paid a smaller dividend to Main Street Capital in the first quarter of 2017 than in the first quarter of 2016, and Main Street Capital has been marking down the value of its equity investment in recent quarters.
For those following along, Main Street's troubled retailers plus its Jensen Jewelers stake add up to about $0.79 of book value per Main Street Capital share.
An oddball
Main Street is a lender and equity investor in Glowpoint, a publicly traded company, and further write-offs seem certain. The question is when, not if, this equity investment gets marked to zero, in my opinion.
|
Investment in Glowpoint |
Mark |
|---|---|
|
12% secured debt |
34% of cost |
|
Common stock |
$0.29 per share |
Data source: Data from SEC filings; calculations by author.
Glowpoint is a good example of where good accounting makes for bad numbers. Main Street appropriately marked its Glowpoint common stock at $0.29 per share, consistent with trading prices. However, given that it values its debt investment in Glowpoint at $0.34 on the dollar, it's likely that the equity is eventually written down to zero.
The Glowpoint equity isn't a big deal -- it makes up about $0.05 of Main Street's book value on a per-share basis -- but I think you can safely write it off.
All about downside
With more than 200 investments, Main Street Capital will probably have winners just as it has losers. The fact is that no business-development company (BDC) should be expected to bat 1.000, given that investing in small businesses is inherently risky.
That said, it's my view that shrewd BDC investors should focus on quantifying the downside rather than the upside with any given BDC. The upside takes care of itself in the form of big dividend yields that BDCs pass on to their investors with regularity; it's the downside investors should worry about.
For Main Street Capital, the big risks are permanently low oil prices and continued retail weakness. Oil and gas companies and problematic retailers make up approximately 14% of book value combined. That's no rounding error for a BDC that is arguably priced for perfection.
