Will Apollo Investment Outgrow American Capital and Ares Capital?

Apollo Investment (AINV -0.07%) will release its quarterly report on Friday, and investors are prepared to see little change in the business-development company's earnings from year-ago levels. What they're anxious to see, though, is whether Apollo Investment will keep its dividend at its current levels, which gives the BDC a yield over 9%. This is higher than rival Ares Capital (ARCC 0.24%), and helps distinguish it from American Capital (ACAS), which hasn't paid a dividend in years.

The idea behind business-development companies like Apollo Investment is that, in order to encourage investment in small privately held companies, the tax laws give BDCs certain benefits over ordinary companies. In exchange for avoiding corporate taxation, Apollo, Ares, and American Capital have to pay out the bulk of their income as dividends. In Apollo's case, that has produced impressive dividends; but the earnings that support those payouts haven't grown as much as investors would have liked in recent years. Let's take an early look at what's been happening with Apollo Investment over the past quarter, and what we're likely to see in its report.

Stats on Apollo Investment

Source: Yahoo! Finance.

Can Apollo Investment earnings start to grow again this quarter?
In recent months, analysts have gotten more enthusiastic about Apollo Investment earnings prospects, raising their full-year fiscal 2014 estimates by a $0.05 per share. The stock has also gained ground, rising 8% since early August.

Apollo Investment came into the quarter with some positive momentum, as it reported better-than-expected investment income for its June quarter. At $0.25 per share, investment income rose almost 20% from year-ago levels, with net asset growth of 9% coming largely from raising capital through a secondary share offering, and issuance of long-term unsecured debt. Apollo made investments in 23 new companies during the quarter, exiting 10 positions. On the downside, though, Apollo saw net realized and unrealized losses of $0.16 per share, weighing down total earnings.

Apollo and its peers see great opportunity in rising levels of merger and acquisition activity. Ares Capital CEO Mike Arougheti said a few months ago that Ares had seen new deals from M&A rise compared to recapitalization and refinancing transactions, boding better for high-quality investment opportunities. Similarly, Apollo President Ted Goldthorpe pointed to less reluctance among companies to consider mergers. That might not be as important for American Capital, with its huge mortgage-management subsidiary, but for Apollo and Ares, it could be a major growth driver.

One challenge that Apollo has faced is generating enough income to cover its dividends, with the BDC having cut its payout last year in light of falling income levels. Risky strategies like payment-in-kind loans make up a greater part of Apollo's overall investment income than they do for rivals Prospect Capital (PSEC 0.46%) and Main Street Capital. Both of these companies have had more stable payouts than Apollo, and trade at premiums to their net asset value.

In the Apollo Investment earnings report, be sure to watch for trends on how much income it's able to generate from its investment portfolio. With the credit markets in flux awaiting the Federal Reserve's final action on quantitative easing, Apollo needs to demonstrate it can match Prospect Capital and Ares Capital in developing high-quality income streams to keep dividend investors happy.

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