Dividend Growth Is The MAIN Thing - Part One

Mar.12.13 | About: Main Street (MAIN)

Main Street Capital Corporation provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies. Main Street's predecessor investment funds were originally founded in 1997. MAIN's IPO was on October 9, of 2007 at a price of $14.88 and at a dividend of $0.33/share/quarter. It currently pays a dividend of $0.15/month and will increase that payout to $0.155/month in April. MAIN is one of very few BDCs [Business Development Companies] that did not cut its dividend during the financial crisis.

MAIN closed Friday at a 5.39% yield based on its March dividend. The sector average of dividend-paying BDCs in my coverage universe was 8.79%. Does MAIN deserve to sell at such a large discount based on yield?

It is my theory that all income stocks sell at something close to logical yield plus CAGR [or projected dividend Compound Annual Growth Rate] metric - with [1] an adjustment for dividend security and [2] an adjustment to the CAGR that varies with the confidence the market has in the CAGR projection.

For MAIN to be selling at a correct or low valuation [and thus be worthy of your purchase], I will need to provide evidence that it merits a significantly higher CAGR projection than the average BDC. It would help if MAIN's NII projection merits more than an average level of confidence. I believe the case can be made for both arguments.

In part one of this article, I will show my Q4-12 metric intensive update for MAIN along with my run rate NII projection. In part two, I provide two spreadsheets on year-to-date BDC performance and valuations; and show my analysis of MAIN's current valuations.

MAIN Reports NII of $0.5614/share compared to a forward Div of $0.465/quarter
What It Earned Main Street Capital reported for Q4-12 Total Investment Income of $26.165 million [$0.8102/share] and Net Investment Income of $18.128 million [$0.5614/share]. The Net Increase in Net Assets Resulting from Operations was $24.487 million [$0.7583/share]. NAV was $18.59 compared with $17.49 last quarter and $16.89 at the end of Q2-12. Distributable net investment income [NII + share based compensation expense of $0.705 million] was $18.833 million [$0.5832/share]. Net payment-in-kind interest for the last four quarters was $4.425 million or an average of $1.10625 million/quarter.
The ratio of total operating expenses, excluding interest expense, as a percentage of average total assets was 1.8% on an annualized basis for the three months ended December 31, 2012. The Ratio of total expenses to average net assets was 8.18% [all ratios are for the last 12 months]. The Ratio of net investment income to average net assets was 11.57%. Portfolio turnover was 56.22%.

Interest, fee and div income: Q4-12 Q3-12 Q2-12 Q1-12 Q4-11 Q3-11 Q2-11 Q1-11 Q4-10 Q3-10 Q2-10

Control investments 6,911 5,991 6,083 5,767 6,474 6,361 6,491 5,650 4,902 4,497 4,532
Affiliate investments 5,688 4.838 4.141 5,673 4,091 3,185 3,113 2,146 2,513 1,975 5,259
Non-Control/Non-Affiliate 13,503 12,015 10,101 8,147 6,183 4,700 4,325 3,311 3,074 2,124 2,549
Total interest, fee and divs 26,102 22,844 20.842 19,587 16,748 14,246 13,930 11,128 10,488 8,597 8,172
Int from marketable securities 63 110 517 972 2,924 2,839 2,199 2,247 1,189 408 560
Total investment income 26,165 22,954 20,842 20,559 19,672 17,086 16,129 13,374 11,677 9,005 8,732

Investment portfolio 924.431 834.592 798.943 664,299 563,879 469,990 471,729 392,526 348,811 348,811 348,811

Click to enlarge

What It Owns MAIN had debt and equity investments in 59 Lower Middle Market [LMM] companies collectively totaling approximately $510.3 million in fair value or $408.0 million at cost. Approximately 76% of Main Street's LMM portfolio investments at cost were in the form of secured debt investments, and 94% of these debt investments were secured by first priority liens on the assets of portfolio companies. The LLM's portfolio weighted average annual effective yield on debt investments was 14.2%. MAIN has equity investment in over 90% of the portfolio - with some of that equity generating dividends.
MAIN's middle market [MM] portfolio investments ["Non-Control/Non-Affiliate investments"] were in 85x companies collectively totaling approximately $390.0 million in fair value with a total cost basis of $385.5 million. MAIN's middle market portfolio investments are primarily in the form of debt investments, and 92% of such debt investments at cost were secured by first priority liens on portfolio company assets. The weighted average annual effective yield on the middle market portfolio debt investments was approximately 8.8%.

Originations For Q4-12 MAIN completed $58.1 million in total LMM portfolio investments, including investments in four new LMM portfolio companies totaling $50.5 million, which after aggregate repayments on debt principal and return of invested equity capital from several LMM portfolio investments resulted in a net increase in the LMM portfolio investments of $41.5 million. MAIN had a net increase in middle market portfolio investments of $37.4 million in six middle market companies.

A top down Run Rate NII Projection MAIN fails to provide detail on fee and dividend income, making a good top down NII projection an unlikely outcome. I will use half of the Q4-12 originations for my portfolio growth projections - and again cut those numbers in half for portfolio growth due to those new investments producing income for only half the quarter. So the additions to the existing two portfolios are half of 20 million for the LMM and half of 16 million for the MM. The LMM has 76% of a projected portfolio of [510 + 10] $520 million with a 14.2% return - generating $14.030 million in TII. The MM has a projected [390 + 9] 399 with an 8.8% return - generating $8.778 million in TII. This sums to $22.808 million compared to Q4-12's $26.165 million. There was $1.700 million from prepayments fees in Q4-12 and 'special' equity dividends of $1.400 million. Detail on regular equity dividends was not provided. Subtracting the two line where we have detail would result in [26.165 - 1.700 - 1.400] an adjusted Q4-12 'pre-fee and dividend' TII of $23.065 million. So we can see that the top down projection is in the right neighborhood. But we are lacking the detail to get us on the right block in that neighborhood.

But MAIN did provide its outlook for Q1-13 in its conference call. It projected that NII would only be $0.03/share above the dividend. TII/share would drop due to dividend and fee income being higher than run rate in Q4-12. That would mean NII/share of $0.495/share. Of the last nine quarters, NII/share has risen in eight. So going by that trend alone, Q2-13 would be close to $0.52; Q3-13 would be $0.53; and Q4-13 would be $0.56/share. That sums to $2.105/share while the consensus analyst projection is $2.04/share. This short-cut method of NII projection is too crude for me to use on a regular basis. I do not like using it. On the other hand, MAIN has had atypical regularity in its NII/share/quarter growth - and that factor makes this type of guesstimate worthy of some consideration.

Portfolio Quality Metrics As of 12-31-12, MAIN had no debt investments which carried a fair value on non-accrual status - and had one investment with no fair value that represented 0.2% of total portfolio at cost that was on non-accrual. The LMM portfolio companies had a weighted average net senior debt to EBITDA ratio of approximately 2.0 to 1.0 and a total EBITDA to senior interest expense ratio of approximately 4.0 to 1.0. Including all debt that is junior in priority to Main Street's debt position, these ratios were approximately 2.2 to 1.0 and 3.8 to 1.0, respectively.

What It Owes With Long-term debt ['SBIC debentures' with a weighted average cost of 4.7% and a weighted average duration of 6.4 years] of $211.467 million [cost at par was $225 million] and 'credit facility' of $132.000 million [MAIN has the election of the applicable LIBOR rate (0.21% as 12-31-12) plus 2.50% or Prime Rate (3.25% as of 12-31-12) plus 1.50%]. The total debt was $343.467 million. With shares outstanding of 34.589 million, the Debt/share was $9.9299 and the Debt/NAV ratio was 53.41%.
MAIN has a number of SBIC debentures with interest rates in the 6s, with these being the first to mature. MAIN may have significant opportunities to lower their cost of debt. The most recent debenture has a yield or cost of 1.446%.
MAIN had 2013 debt maturities of zero; $6.000 million in 2014; $23.100 million for 2015; $5.000 million for 2016; $44.700 million for 2017; and $146.200 million for 2018 and thereafter. Total interest due plus debt maturities were $10.627 million for 2013; $16.793 million for 2014; $33.382 million for 2015; $14.141 million for 2016; $52.953 million for 2017; and $163.340 million for 2018 and thereafter.

I will continue this discussion on MAIN in part two.

Disclosure: I am long MAIN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.