Key Highlights

● A brokerage initiated coverage of Ares Capital with a strong-buy rating, without a price target.

● Third-quarter Earnings of 46 cents a share missed the 48-cent consensus.

● Markets put about 85% odds on a December Fed rate hike.

● The stock opened at $19.12 on Thursday and has a Beta of 0.61.

Ares Capital (NASDAQ:ARCC) is under the spotlight on Friday after a brokerage initiated coverage of the business development company. Market data, citing a research service, reported the initiation on Oct. 30. It labeled the rating "strong-buy" and said the research note was issued Thursday. No price target was given in the report.

No confirmed pre-market quote for Ares Capital was available as of about 8:30 a.m. ET. Market data said the stock opened at $19.12 on Thursday. The shares are on watch rather than moving in a confirmed direction.

The brokerage joins a largely positive group of analysts. Market data shows one strong buy, eight buys and two holds, for a consensus of "Moderate Buy" and an average target of $20.39. Recent actions include one brokerage cutting its target to $18.50 from $19 with an overweight rating, and another trimming its target to $21 from $22 while keeping a buy.

A mixed quarter

The initiation comes days after Ares Capital's third-quarter report on Oct. 27, which fell short of expectations. Earnings were 46 cents a share against a 48-cent consensus, down from 50 cents a year earlier, according to market data. Revenue was $763 million against an estimated $776.34 million, down 2.4% from a year earlier.

Those numbers highlight a key issue for the sector. Business development companies lend mostly at floating rates, so their income tends to fall when rates drop and rise when they climb. Spreads on new loans have also been under competitive pressure as more capital flows into private credit.

Ares Capital lends to middle-market US companies, mostly through first-lien senior secured loans, with smaller amounts of second-lien loans, subordinated Debt and equity. Founded in 2004, it is externally managed by an affiliate of Ares Management (NYSE:ARES). Market data puts its Market Value at about $13.8 billion and its price-to-earnings ratio at about 15.7, with a 52-week range of $17.40 to $21.14. Analysts expect earnings of $1.89 a share for the current fiscal year, and institutions hold about 27% of the stock, according to market data.

Ares Capital trades on Nasdaq and is included in the FT Wilshire 5000, a broad measure of US-listed equities. Its low beta of 0.61 means it has historically moved less than the overall market.

Rates are the swing factor

The rate outlook has shifted in a way that could help lenders like Ares Capital. The Federal Reserve hiked in September and held rates at 3.75% to 4.00% this week. Markets put about 85% odds on a December hike, according to market data. Higher short-term rates would lift income on floating-rate loans, though they also strain borrowers' ability to pay.

The broader market offers a mixed setting. Market quotes at about 8 a.m. ET showed S&P 500 futures down 1.1% and Nasdaq-100 futures down 2.6% after Amazon (NASDAQ:AMZN)'s and Intel (NASDAQ:INTC)'s results, while Dow futures held flat. Financials are among the sectors on track for solid October gains, according to media reports.

Risks and what to watch

Credit quality is the main risk. A slowing economy or prolonged high rates could raise non-accrual loans, where borrowers stop paying. Investors will want the details behind the brokerage's view, including its target and its assumptions on Credit losses and Dividend coverage.

Next, watch Ares Capital's trading at the 9:30 a.m. ET open and peer BDCs for any sector read-through. Watch also for the October jobs report on Nov. 6, which will shape expectations for the Fed's December decision.