The Weekly Summary
Tension around the viral outbreak in China has subsided even though the disease itself has now killed more people than SARS back in 2003 . . . and while the coronavirus has been largely contained, new infections continue to multiply within the quarantine zone. We'll soon be able to gauge the ultimate impact on global health and the world economy. For now, this is the only story that can distract Wall Street from strong U.S. data and corporate earnings. The background tone is extremely bullish. If not for the headlines, investors would have nothing to do but sit back and enjoy the rally.
The CBOE Volatility Index (^VIX) dropped 18% last week but remains elevated at 15.5. "Calm" periods generally start when the VIX recedes below 12, so we are still a long way from smooth waters. The mood around Asia is brittle with Chinese stocks down 7% YTD and other markets in the region feeling contagious pressure. Bangkok, Seoul and Taipei have dropped in sympathy with Shanghai. Much of the relief from the recent truce in the trade war has evaporated.
However, the trade war also ensured that forward-looking U.S. companies already pulled their operations and supply chains back from China in particular. Many critical cross-border economic relationships have always unwound, leaving our recommendations in a much better position to roll with developments. A few years ago, shutting down a few Chinese provinces (45 million people) would have been extremely disruptive to the global system. Now that system is more resilient. Life goes on and resources are available to solve emergent challenges.
Think of historical natural disasters and the logic becomes clearer. Wall Street is not writing off those people or whistling in the dark here. Instead, the response demonstrates investors' innate confidence in human ingenuity and our ability to bounce back from earthquakes, storms, famines and viral outbreaks. Someone is going to cure this disease. That simple fact has driven a lot of money into Healthcare stocks that were previously ignored. Our Healthcare portfolio is up a healthy 2% this week and we see great things ahead.
As it is, great things are happening throughout the BMR universe. Only five of our stocks lost ground last week and all of our portfolios collectively rebounded close to 3%, which is enough to keep subscribers ahead of the major indices YTD. Our strength was in the way our High-Yield positions held up during the market's nervous phases, shielding the overall return profile from the downside.
Unlike the market as a whole, we never slipped into negative territory. Instead, the "January Effect" is still alive and well in our corner of the market . . . and statistically speaking, that's usually a very good thing. BMR stocks are now up 7% in the last six weeks, starting the year stronger than the Nasdaq, S&P 500 or blue-chip Dow industrials. So far, so good.
There’s always a bull market here at The Bull Market Report! This week our earnings cycle doesn't start until Tuesday night, so we're using this time to get ahead of Akamai's results so they don't get lost. It's also an ideal week to update you on our latest thoughts on the Healthcare group, including Exact Sciences, which also reports Tuesday night. Blackstone is also worth a fresh look.
Gary Jefferson has more to say about coronavirus and The Big Picture has a simple but extremely encouraging note on earnings. Then The High Yield Investor looks at sustainable dividends. In a world where the Fed is guiding interest rates below inflation, bonds are a losing scenario. These stocks and funds compensate for that.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: The Best Number Of The Year
Let's keep this simple so the ramifications aren't lost. As of now, earnings for the S&P 500 are once again trending higher than they were a year ago. We haven't been able to say that since the 4Q19 numbers came in last February and profit throughout the market effectively peaked. The year of deterioration has been frustrating for investors, forcing many to tolerate unusual and unsustainable high valuations as stocks soared while the fundamentals behind them stalled.
A year ago, the S&P 500 commanded a 15.8X earnings multiple. Now the same stocks are booking almost exactly as much profit but have swelled to 18.8X earnings. What's changed? The Fed swinging to a more relaxed posture has taken a lot of the risk out of the market, reducing the financial consequences of making the wrong bet on stocks while driving a lot of money from Treasury bonds, which are now a losing proposition in the face of government bankers' 2% inflation target. People simply need their money to deliver more than 2% a year to maintain purchasing power. They aren't going to get that in bonds any time soon.
Nonetheless, crowding into low- and no-growth stocks wasn't an appetizing prospect, even if "There Is No Alternative" or "TINA" as some on Wall Street have started to say. We've all been trained to think of these multiples as dangerously high even when the Fed is on our side.
That's why we stuck to companies that are actually growing. And it's why it's great to see that at last the market as a whole has joined in. Earnings growth isn't spectacular. Profit for the S&P 500 is tracking just 0.7% above last year's level. But even a mild expansion helps push the valuation numbers back in the right direction.
If earnings remained flat, stocks would need to stretch to a 20.7X multiple in order to give investors a "normal" 10% annual return. Here at 0.7% growth, that same performance would translate to a 20.5X multiple . . . still not great by most standards, but better than the alternative. And after months of active deterioration, the future can easily get brighter from here. We suspect the S&P 500 will give us at least 3% growth in the current quarter and about 10% over the next year.
That's enough to keep valuations from stretching at all. If the numbers are good enough, we could see either bigger returns or declining valuations. Based on what we know about Wall Street psychology, the former case is more likely. It's going to take a serious economic event to drive money out of the market at this point . . . a shock rate hike (unlikely), a recession (likewise) or some other shock to the global system. Barring that shock, the trend is once again constructive. Investors who held on can now point to these numbers as evidence for their patience. And those who were waiting on the sidelines know that the window to buy back in is closing fast.
Agilent Technologies (A: $83, up 1% last week)
Agilent Technologies has been on a tear over the last decade. After plummeting to $9.00 in 2009, a historic low, the stock has experienced a meteoric rise that has been nothing short of spectacular. Over the last three years, Agilent has more than doubled from $36, reaching an all-time high of $83.
Agilent has three businesses: Life Sciences and Applied Markets, CrossLab, and Diagnostics and Genomics. Life Sciences and Applied Markets generates the largest share of Agilent’s revenue, 45%, and has the highest margin. This business provides applications, such as instruments and software, that allow its customers to identify and analyze properties of substances and products. These are sold to a range of markets, including for-profit Pharmaceutical and Biopharmaceutical companies, Academic/Government, Chemical/Energy, Environmental, and Food.
CrossLab (36% of fiscal 2019 revenue ended October 31, 2019) provides consumables to labs. These are chemistries, supplies, services, and software, which are sold to the same markets as Lifesciences; hence, there is much customer overlap which makes selling easier.
Diagnostics (20% of fiscal 2019 revenue) provides active pharmaceutical ingredients for therapies. These include exciting areas such as DNA mutation testing, genomic testing, and solutions that help identify DNA associated with genetic diseases and help decide on cancer treatments.
The three units had revenue increases in 4Q19 and FY19. For 4Q19, total year-over-year revenue growth was 6%, rising from $1.3 billion to $1.4 billion. Profits were flat, at $195 million, due to higher expenses across the board. While this is not what we like to see, we note that the company kept a lid on costs for most of the year. As long as revenue growth continues, we expect Agilent’s bottom line to increase going forward.
Investors can take heart in the prodigious cash flow that the company generates. FY19’s operating cash flow was down a bit, from $1.1 billion to $1 billion. Free cash flow was $850 million, which management used on dividends and repurchases. Last year, they spent $725 million on buybacks, up from $420 million. Management has shown confidence in their growth prospects by annually increasing the dividend payout. This includes the most recent January dividend, which the board raised by 10% to $0.18.
BMR Take: Agilent has consistently produced a mid-to-high single-digit revenue increase over the last few years. Management expects FY20’s revenue to reach $5.5 billion, 7% growth. We have a $100 Target Price and a Sell Price of $74.
AstraZeneca (AZN: $49, up 1%)
AstraZeneca has nearly doubled in three years, zooming from $27 in late 2016 to an all-time high of $50 a month ago. The stock has settled down a bit with the market selling off. With strong revenue growth and an exciting drug pipeline, we have no doubt the stock will resume its upward climb.
Oncology is a major focus, accounting for 36% of revenue. It is the biggest and fastest growing area. For 9M19, Oncology’s revenue increased by an eye-popping 50%, to $6.4 billion. This was led by Tagrisso ($2.3 billion, up 80%), Imfinzi ($1 billion, up 180%), and Lynparza ($850 million, up 90%).
The other major areas are also doing well too. Respiratory’s sales grew 9% year-over-year, to $3.9 billion, led by Pulmicort’s 17% growth, to $1.1 billion. Fasenra, a treatment for asthma, saw its sales grow an incredible 190%, to $500 million. The two drugs more than offset weakness in Symbicort, whose sales fell by 7% to $1.8 billion due to competitive pressures that hurt pricing.
Cardiovascular, Renal, and Metabolism (CVRM) experienced an 11% sales growth, with 9M19 sales reaching $3.2 billion. Most of the sales are represented by Brilinta ($1.2 billion, up 22% year-over-year) and Farxiga ($1.1 billion, 13% year-over-year increase). YTD revenue increased by 13% versus a year ago, to $17.7 billion.
When the company reports 4Q19 results later this month, we look for continued strong growth. AstraZeneca’s pipeline looks strong, bolstering our confidence in the company’s prospects. In 2020, there are several drugs that management expects to receive approval, including Imfinzi and Lynparza for other indications.
BMR Take: AstraZeneca offers good growth prospects plus a 2.8% dividend yield. A strong drug pipeline, notably in the fast-growing Oncology market where its treatments have gained acceptance in a competitive field. Not to be forgotten, Respiratory and CVRM are also growing nicely. Our Price Target is $58, and we have a Sell Price of $44.
Eli Lilly (LLY: $146, up 5%)
Eli Lilly has more than doubled since 2016’s $68. The stock has kept going up, now trading at an all-time high. Since October, the stock is up 33%. This established drug company has proven that strong growth can continue, provided it is well managed. That is exactly the case here.
After a lackluster 2% revenue growth for 9M19 versus 9M18, the rate accelerated to 8% in 4Q19. Revenue rose from $5.6 billion to $6.1 billion. This drove income 33% higher, to $1.5 billion compared to 4Q18’s $1.1 billion.
Eli Lilly’s drug pipeline is paying off. There was continued momentum in blockbuster drug Trulicity, whose 4Q19 sales grew by 31%, from $925 million to $1.2 billion. Taltz (treatment for psoriatic arthritis) was another strong performer, with quarterly sales of $420 million, 37% higher. Basaglar (insulin to treat diabetes) and Cyramza (cancer treatment) continued to have nice top-line gains. Olumiant (used to treat rheumatoid arthritis) is growing by leaps and bounds, including an 82% year-over-year rise in 4Q19, to $130 million
With new drugs on the market and more on the way, Eli Lilly’s low revenue growth is a thing of the past. Management’s 2020 revenue expectation is $24 billion, an 8% increase. They lowered EPS guidance by 20 cents to $6.23 due to the planned $1.1 billion Dermira acquisition. No one should complain about 25% year-over-year earnings growth.
Speaking of the Dermira deal, this expands Eli Lilly’s immunology pipeline, specifically skin conditions. This includes lebrikizumab, which is in Phase 3 trials, which is designed to treat moderate-to-severe dermatitis. The FDA granted the treatment Fast Track status, which is designed to speed the development and review process for drugs that fill unmet medical needs and treat serious conditions.
BMR Take: Eli Lilly’s renewed growth has invigorated the stock. The company has so much faith in its prospects that the board recently raised the quarterly dividend by 15% to $0.74. This follows the same rate of increase in 2019. Accelerating revenue and bottom line growth along with a growing dividend (2% yield) is a nice, albeit rare, combination. That is why we do not have a Sell Price: We like to hold on to these companies when we find these opportunities. Our Target Price is $170.
Exact Sciences (EXAS: $95, up 2%)
Exact Sciences sold off by 18% following its preliminary 4Q19 results on January 10, going from $104 to $86. The stock has recovered somewhat to $97. We’ve dug into the press release and the company’s prospects and find nothing troubling. In fact, their rapid revenue growth has continued.
Management expects 4Q19 revenue of $295 million, more than double 4Q18’s $145 million. Part of this is due to the Genomic Health acquisition, which closed in November. This piece, Precision Oncology, added $65 million in less than two months. If the company had owned it for the entire quarter, revenues added would have been 13%, to $120 million. The acquisition adds the well-regarded Oncotype DX to its cancer diagnostics platform. This helps doctors and women with breast cancer choose the optimal treatment plan. In 4Q19, there were 41,000 tests, up 14% year-over-year.
Meanwhile, its core Screening business continues to post remarkable growth. Based on preliminary results, revenue grew by 60% in 4Q19, to $230 million. Its at-home Cologuard test is driving this growth. Colon cancer is the second leading cause of cancer death in the United States and it is one of the most preventable. This is where Cologuard comes in, simplifying the process by allowing patients to take a quick and easy, non-invasive sample at home and mail it in. It sold 475,000 units in 4Q19, 63% higher than a year ago.
BMR Take: It’s hard to imagine what else investors wanted to see out of Exact Sciences in 4Q19. After prudently re-examining the company, we still like the company’s prospects. For us, we see continued revenue growth as the at-home tests gain acceptance from patients and doctors. We expect this to lead to profitability down the road. Right now, the company is spending to gain acceptance in the marketplace. Our $145 Target Price may seem ambitious, but remember: it is only 20% off September’s all-time high of $121. Exact Sciences dipped below our $93 Sell Price, but it is now trading above that level. We love this company. We'll see you Tuesday morning with our Earnings Preview.
Johnson & Johnson (JNJ: $152, up 1%)
When a company as large as Johnson & Johnson (current market cap: $400 billion) rallies 20% in less than four months, this is noteworthy. The stock reached an all-time high of $154 this week. You won’t hear us complaining.
Investors had punished Johnson & Johnson over its exposure to opioid lawsuits. The worst-case scenarios have not played out and litigation risk appears manageable. A lawsuit brought by Oklahoma resulted in a $570 million judgment against the company, which it is appealing, and there is a preliminary agreement with four states whereby the company would pay $4 billion. It still faces litigation over talc in its baby powder, which presents a risk. It is important to remember that this is a AAA credit rated company with $18 billion in cash.
With concern over opioid litigation fading, we can turn our attention to the fundamentals. Sales grew 2% in 4Q19, to $20.7 billion versus 4Q18’s $20.4 billion. This tepid rate did accelerate from 9M19, when it was flat versus the year-ago period.
The Pharmaceutical business continued to lead the way, with a 4Q19 sales increase of 4%, from $10.2 billion to $10.5 billion. This was led by several drugs, including Stelara, Darzalex, and Imbruvica. The future looks good, too, with European approvals for Spravato, a nasal spray used to treat depression, and Darzalex for multiple myeloma when used in combination with other drugs.
Medical Devices were a slight drag, with sales falling from $6.7 billion to $6.6 billion. The good news is that the performance stabilized from earlier this year. Consumer’s 4Q19 sales were flat, at $3.6 billion versus $3.5 billion
Income was 32% higher, growing from $3 billion to $4 billion. Due to strength in Pharmaceuticals, management expects 2020 sales to grow by a solid 5%, from $82 billion to $86 billion.
BMR Take: Johnson & Johnson’s sales growth is speeding up. A mid-single-digit growth rate for a company this size is nothing to sneeze at, and we expect this to move at a faster clip once the other two businesses get moving. A model of consistency, the company has raised its dividend for 57 straight years. The current yield is 2.5%. The stock has surpassed our $150 Price Target, so we are raising it to $168. We like this company so much that we do not think an investor should ever sell.
Blackstone Group (BX: $63, up 3%)
Blackstone has risen 80% over the past year, up from $35. The stock has skyrocketed to never before seen heights. Part of last year’s extraordinary increase was due to Blackstone changing its ownership structure from a limited partnership to a corporation. This created more liquidity for the stock since it opened the pool of buyers to mutual funds and others. The corporate tax obligation is modestly higher, but not as severe since the Tax Cuts and Jobs Act of 2017 went into effect in 2018.
The other part of its success is the company’s performance. This is good news since this ultimately drives the stock. Blackstone is a leading Alternative Asset Management company, investing in real estate, private equity, hedge funds, and credit.
It has built an enviable long-term track record in these areas. Assets under management are $570 billion at year-end, an increase of 20% from 2018. This is reflected in Management and Advisory Fees, which grew to $3.5 billion in 2019 versus 2018’s $3.0 billion.
Revenue grew 7% year-over-year in 2019, from $6.8 billion to $7.3 billion. Aside from Management Fees and Incentive Fees, Blackstone generates revenue from Investment Income, which are more volatile, and Interest/Dividends. Income rose from $3.3 billion to $3.9 billion.
Dividend payouts are volatile. Blackstone’s 1Q20 dividend is $0.61, 5% higher than 1Q19. The last four dividends equal $1.95, a 3.1% yield.
BMR Take: Owning stock in a high-caliber money manager is a tempting proposition that investors should seriously consider. With institutional ownership constraints taken off, this cash-generating machine is set to go even higher. We like the company so much that we are increasing our $62 Target Price, which Blackstone has blown past, to $72. We have a $52 Sell Price.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
How long will the coronavirus panic stay in play? It appears that once new cases begin to decline, the quarantine imposed by the Chinese government will have worked and this “threat” to the markets will subside. We will, however, have to wait for the numbers and so the markets will continue to be volatile and headline driven until then.
Even so, since the S&P 500 finished January down, the January Barometer is now negative this year. History is now no longer on the side of the market. Every down January since 1950 was followed by a new or continuing bear market, a 10% correction or a flat year. If the spread of the coronavirus is slowed or contained quickly, then we believe this is a “one-off” and the market will quickly regain its footing on its way to recovery. In other words, without the virus, the market was well on its way to a positive January. Factor out the virus and statistics are back on the bulls' side.
After all, the markets have always rallied after selloffs caused by biological epidemics such as SARS. Thus, we may not actually be facing a 10% correction here . . . although most years will deliver at least a transient dip regardless of what happens in January. The important thing is where we end up in December and beyond. We do not expect a bear market because we believe earnings can still carry the market higher unless there is some sort of “black swan” event such as a real coronavirus pandemic that continues to worsen.
This year’s combination of a positive Santa Claus Rally and First Five Days with a full-month January loss has only occurred eleven times (including this year) since 1950. In the previous ten occurrences the S&P 500 was down six times in February with an average loss of 1.5%. However, over the remaining 11 months of the year, the S&P 500 advanced 80% of the time with an average gain of 7.4%. Full-year performance was positive 70% of the time, but with an average gain of 2.9%.
Again, we believe if the worst of the coronavirus passes in the next few weeks, and earnings come in as expected, 2020 should end up much better than a “flat” year. Even so, while having 70% historical odds to achieve an average gain of 2.9% is not the kind of history we would prefer, it's a nice base. Stocks are statistically positioned to beat bonds by at least 1% and there is significant room for upside beyond that minimal but positive floor.
Keep in mind the most recent GDP report showed that the economy grew at a 2.1% annual rate in the fourth quarter, in spite of an unusually large slowdown in the pace of inventory accumulation. Real GDP was up 2.3% versus a year ago. Very importantly, this morning’s January ISM manufacturing index rose back into expansionary territory, suggesting that the recovery is on solid footing. Auto sales, too, look healthy, and Friday's jobs report was more than respectable.
Bottom line: A solid earnings season along with a good economy and accommodative monetary policy makes a strong case for 2020 being a positive year rather than a flat or bearish one.
Earnings Preview: Akamai (AKAM: $96, up 3%)
Earnings Date: Tuesday, 5:00 PM ET
Revenue: $749 million
Net Profit: $185 million
Year Ago Quarter Results
Revenue: $713 million
Net Profit: $176 million
Implied Revenue Growth: 5%
Implied EPS Growth: 5%
Target: $100 (almost there!)
Sell Price: $77
Date Added: June 8, 2018
BMR Performance: 23%
Key Things To Watch For in the Quarter
Akamai has spent the last few years pivoting from low-margin legacy businesses to more exciting corners of the Data Services landscape. That has translated into significant earnings gains while the headline revenue numbers remained relatively constant . . . the top line wasn't rising much, but every dollar coming in translated into a better profit.
This quarter, that narrative may not progress far. We're simply looking for evidence that Akamai is still growing faster than the market as a whole, and that's a low bar. The real sizzle in this earnings report will be guidance. We want management to demonstrate confidence that profit for 1Q20 will come in at $1.16 and then hold on at roughly that level for the remainder of the year. If that's the case, the company can continue on its current course for a long time to come.
And we aren't ruling out revenue gains, either. Management has had a few years to see where the hot spots are. Pivoting to capture bigger customer relationships can turn what's currently persistent sales growth into something more powerful. Even 7% more revenue in 2020 than what we saw in 2019 will justify our bullish view. Anything better will force us to raise our Targets awfully fast.
The High Yield Investor
After falling for most of 2020, yields rose across the board this week. This was fueled by optimism earlier in the week that research teams in China and Great Britain were near discovering a treatment for the coronavirus. The stock market reacted positively, pulling Treasury prices down and yield higher.
After initially rising earlier in the week, Treasury yields gave some of the increase back in the latter half. This shows us that, while yields may fluctuate in a band, they are not about to spike anytime soon when there is no hint of rising inflation. On the last day of the week, yields fell due to renewed fears about the coronavirus and the effect on worldwide growth. The World Health Organization flashed a caution sign regarding the illness. There was also weak European economic data, particularly German industrial production.
Friday’s movement came despite positive economic data on productivity and wage growth. This culminated with a better-than-expected reading on jobs, which showed 225,000 created. This was well ahead of the 160,000 expected. A stronger economy typically causes bond yields to rise.
After all that, the two-year yield rose from 1.33% to 1.41% while the 10-year yield jumped from 1.51% to 1.59%. The 2-10 spread in US Treasuries remained at just 18 basis points. This is a narrow spread that thus far shows no sign of inverting, which most times indicates a pending recession. We watch this closely, every day.
The economic data affirms our view. There are no signs of a slowdown on the horizon, with January’s Jobs Report providing the latest evidence. This has allowed the Federal Reserve to keep rates low for the foreseeable future. The Bull Market Report continues to plug away, turning today to three investments that we like for different reasons. First up is an equity and convertible income fund for more conservative investors, offering a nearly 500 basis point yield advantage over the 10-year yield. For more venturesome investors, we also analyze Apollo Commercial Real Estate Finance (840 basis point yield advantage over the 10-year Treasury) and Ares Capital (680 basis point yield advantage).
AllianzGI Equity & Convertible Income Fund (NIE: $24, up 4%, yield=6.4%)
This is a closed-end fund that seeks to maximize total return through capital appreciation and dividends. There is a fixed number of shares and it trades like a stock. This means it could sell at a discount or premium to Net Asset Value (NAV). In this case, it trades at a discount since its NAV per share is about $25.
The fund, which has been around for 13 years, has compiled a good track record. Since inception, shareholders have earned a 7.2% annual return. Its latest 12-month was an amazing 31%. At year end there were $685 million of assets under management. The past is no guarantee of future performance, of course. We would always rather invest our money with those that have proven themselves.
The year’s performance is particularly impressive considering the stock market soared and the fund’s objective is to balance capital appreciation and income. The portfolio managers may invest between 40% and 80% of the funds’ assets in equity securities and 20% to 60% in convertible securities. They may also engage in covered call writing, a strategy designed to bring in more income by selling call options.
Buying the closed-end fund provides individual investors the opportunity to get a diversified portfolio and tap into lower-risk strategies such as covered call writing while gaining exposure to convertible securities. Converts are appealing since they typically do not fall as much as common securities and share in some of the upside while providing a coupon. These are best left to professionals since it is primarily institutions that trade these securities.
AllianzGI Equity & Convertible Income Fund is now trading above our $22 Target. Therefore, we are raising it to $26. This fund is appealing for more conservative income-seeking investors. The 6.3% yield is nice, plus you get the chance for capital gains.
Apollo Commercial Real Estate Finance (ARI: $18.49, up 1%, yield = 10.0%)
Organized as a REIT, the firm does not invest directly in real estate. The mandate is to invest in the debt underlying commercial real estate. This includes first-lien mortgage loans, mezzanine loans, and subordinated debt, which are all backed by commercial property in the United States and Europe.
In 3Q19, Apollo had 78% of its portfolio in mortgage loans with a 6.8% yield and the balance invested in subordinated loans with a 13.2% yield. It chooses a higher risk, higher return strategy. Apollo invested part of the $6.1 billion portfolio in stressed loans and may even look to distressed ones. To goose returns, borrowing, particularly short-term, is a key part of this strategy.
Apollo has assigned most of the portfolio (63 out of 74 loans, 90% of value) a ‘3’ risk rating, or moderate/average risk on its five-point scale. The ‘1’ (very low risk – Apollo has no loans in this category) or ‘2” (low risk – 8% of the portfolio) rating are the safer investments. Apollo also categorizes those with a ‘4’ (high-risk potential for loss) or ‘5’ (impaired and a loss likely, at 2% of the portfolio for both).
Geographically, commercial loans secured by Manhattan properties comprise 37% of the portfolio and Brooklyn accounts for another 7%. Internationally, the United Kingdom’s properties represent 13% of its loans. Apollo’s 9M19 net interest income, which is the spread between interest income earned on its loan portfolio and interest expense, was $255 million. This was 20% higher than a year ago, when it was $210 million.
The period’s income slipped 5%, from $165 million to $160 million. Obviously, we like to see this number follow revenue’s upward climb. This was due to a greater provision for loan losses and realized losses. Apollo Commercial Real Estate Finance (Target Price: $22) is not for the faint hearted, obviously. Those willing to assume more risk will note the attractive 10.0% dividend.
Ares Capital (ARCC: $19.23, up 2%, yield = 8.4%)
Ares Capital is a business development company that invests in middle-market companies. This is defined as those with earnings of $10 million to $250 million. It primarily invests in first-and-second-lien loans, which range from $30 million to $500 million. For project finance/power generation projects, investments are $10 million to $200 million. Loans have more seniority and are considered safer investments than equity. Ares does pursue non-control stock deals of less than $20 million, typically when it also makes a debt investment.
Middle-market investing is generally riskier than investing in larger companies. There is more potential upside, of course. The middle market space also has less competition, with commercial and investment banks concentrating on larger corporate clients.
Ares’ track record (it has been around since 2004) and size should provide a degree of comfort. Its portfolio consists of 350 investments and $14 billion in assets under management, as of 3Q19. The composition is 45% first-lien loans, 32% second lien, 10% subordinated debt, 5% preferred equity, and 8% common stock.
The weighted average yield of the portfolio is 9%. Ares is scheduled to report 4Q19 results on February 12 and you'll get the Preview in a few days. For 9M19, investment income grew 15% from the year-ago period, from $990 million to $1.1 billion. EPS slipped from $1.66 to $1.38 due to lower realized gains on investments, which are volatile.
Ares Capital is doing so well the stock is now above our $19 Target Price. This is another investment company that has gone up the risk/reward ladder. This is reflected in Ares’ 8.4% yield. It mitigates risk by investing in more secure debt. Middle-market companies are particularly vulnerable when an economic slowdown comes along. As we mentioned previously, we do not see one on the horizon. With the Fed cooperative, this bodes well for Ares Capital. Hence, we are increasing our Target Price to $21.
Todd Shaver, Founder and CEO
The Bull Market Report