Is Ares Capital Corp a Buy After Its Latest Earnings Report?

Ares Capital (NASDAQ:ARCC) has long been a popular stock among income investors, thanks to its high-yielding dividend. The business development company (BDC) currently offers a yield of more than 10%, significantly above the broader market (the S&P 500 yields around 1.1%).

However, its latest earnings report raised some questions about the sustainability of that payout. Meanwhile, a newly announced acquisition could help strengthen its future earnings. Here's a closer look at whether Ares Capital is an attractive investment opportunity following these developments.

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Ares Capital's latest earnings: Dividend coverage is getting tighter

Ares Capital reported $0.46 per share of core earnings in the third quarter, down from $0.50 per share in the year-ago period. That fell short of its quarterly dividend payment of $0.48 per share. That's not an immediate concern, but it does represent a change from the excess dividend coverage it had previously delivered.

That prior excess income currently provides the BDC with a sizable cushion. Ares Capital's CFO Scott Lem noted on the third-quarter conference call that the company finalized its 2025 tax return and determined that it carried forward $1.37 per share of taxable income for distribution this year.

Meanwhile, CEO Kort Schnabel stated on the call that: "We continue to believe ARCC's current regular dividend appropriately reflects the underlying earnings power of the business. While earnings will naturally fluctuate from quarter-to-quarter, the strength of our portfolio, attractive market pricing and terms, the current interest rate environment, and the expected benefits from the acquisition I discussed earlier reinforce our confidence in the current dividend level."

The MFIC acquisition could help

Speaking of that acquisition, Ares Capital recently agreed to buy fellow BDC MidCap Financial Investment Corporation (NASDAQ:MFIC) in a $2.6 billion transaction, including assumed liabilities. Ares expects that the deal will be modestly accretive to core earnings per share and supportive of future dividends. The combination would expand ARCC's portfolio to more than 800 companies with over $31 billion of investments.

MidCap Financial currently has a nearly $2.8 billion investment portfolio across 229 portfolio companies. Schnabel noted on the call that "Based on the depth of our due diligence on each investment in the portfolio," the company believes it has an excellent foundation in place to continue its successful acquisition track record. Once it closes the MFIC deal, it will have acquired all three of the largest BDCs in operation at the time of its IPO more than 20 years ago. These deals have helped ARCC become the largest publicly traded BDC, while supporting its dividend. It has paid a stable or increasing dividend for 69 straight quarters (over 17 years).

Valuation: Is ARCC a buy?

ARCC currently trades around $18.75 per share. At its current annualized dividend rate ($1.92 per share), the BDC offers a 10.2% yield. Meanwhile, the company reported that its net asset value (NAV) per share was $19.31 at the end of the third quarter. That's about a 3% discount to its NAV. That's not necessarily a bargain, considering its NAV has declined from $19.94 per share over the past year due to deteriorating credit quality. However, nonaccruals were only 2.4% at the end of the quarter (unchanged sequentially) and remain below its roughly 3% historical average since the global financial crisis, and below its peers' more than 4% average during that period.

Ares Capital has a solid history of delivering a stable-to-growing NAV. Since inception, its NAV per share has grown by more than 25%, showcasing its disciplined underwriting and ability to grow shareholder value.

Overall, the BDC currently offers a potential double-digit income return before any share-price appreciation, provided it can maintain its current dividend level. It appears to be in a solid position to sustain its dividend, thanks to its ample spillover income, the modest expected accretion from the MFIC deal, and the underlying earnings power of its business. That makes Ares Capital look like a solid buy for income-seeking investors after its earnings report.

Still an attractive income-focused investment

Ares Capital's latest results weren't overly impressive, with its core earnings falling short of its dividend and credit quality weakening modestly. However, the company maintains a diversified portfolio, and its pending acquisition of MidCap Financial Investment Corporation could improve its future earnings power. With shares trading below its net asset value and yielding more than 10%, I think Ares Capital remains an attractive option for income-focused investors willing to accept the risks of private credit. I'd keep a close eye on dividend coverage and non-accrual loans in the coming quarters to ensure the payout remains sustainable.

Matt DiLallo has positions in Ares Capital and MidCap Financial Investment Corporation. The Motley Fool has positions in and recommends Ares Capital. The Motley Fool has a disclosure policy.