Saratoga Investment Stock: Well positioned to raise interest rates

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Published in Value Lab on 17/6/22

Saratoga Investment (NYSE: SAR) is a lender to US companies in the middle market. Although they are diversified, the risks are already systemic and there is nowhere to really hide in the asset markets. Lending to the middle market is more risky and while solvency is not an issue, credit quality should be if employment falls due to double interest rate pressures and some constant inflationary factors. On the other hand, they are well positioned in terms of NII to increase interest rates. While profitability is high and multiples low, we are definitely moving to Saratoga because of the risks of capital depreciation.

Q4 Note

Q4 demonstrates the company’s profile well. There is a high issuance rate and these loans bring good returns. The companies are in the middle market, with between $ 2 million and $ 50 million in EBITDA, so really small companies and a pretty large share of IT borrowers. The origin stimulates the growth of NII, while typical for the previous environment with low percentages, the spreads tightened throughout the year.

Saratoga Investment - diversified in various industries

Industries (Q4 2022 Pres)

Saratoga Investment - BDC's profitability remains strong

Yields (Q4 2022 Pres)

The company is also well diversified geographically, but the problem is that the environment for raising interest rates is a systemic problem for debt as an asset class. Although the company does not have a spread risk, as most of its assets have a variable interest rate, and the debt is mostly fixed and long-term, it has credit risk.

Superiority of Saratoga Investment

D / E ratio (Q4 2022 Pres)

Leverage ratios are quite low due to the company’s profile, with Saratoga having lower interest rates than competitors, but devaluing assets would mean a lot of pain for potential shareholders.

Making an inventory

Consider the following diagram. Due to the closing dates, the financial year 2021 contains the impact of COVID-19.

Increase in assets and credit quality of Saratoga Investment

Loans can fail (Q4 2022 Pres)

The 2022 fiscal year is not an accurate presentation of the main performance, as the mid-interest rate and cost boom would save most companies. As the provisioning rate is high, leading to a 50% increase in AUM, lending takes place in a busy environment and occupies one third of the portfolio. The need to expand the dry powder to safe transactions will mean discounts on credit terms.

In addition, Saratoga invests in customers’ equity, sometimes in connection with debt, so a little in the style of PE. While the market assessment is difficult with stocks, the stock market decline of more than 10% in the last few days means that the value of these relatively risky assets is also falling.

Conclusion

PE is low at 5.6x and the yield is almost 10% with a good history of dividend growth. In the end, Saratoga is quite safe from solvency problems, but there are risks of capital depreciation for shareholders. The Fed no longer has to do with small businesses in the United States, and the market must recognize this newfound problem. Stocks could fall much further as these stock risks become increasingly concerned with inflation and the risk of destroying demand and employment levels, and with other stocks trading with similar multipliers but with much safer end markets. and assets, we transfer shares such as these.

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