This is part two of a look at BlackRock Kelso Capital (BKCC). In part one I covered the Q4-12 earnings release and made my 2013 EPS or NII (Net Investment Income) projection. In part two, I will show a dividend growth expectation and judge BKCC's risk metrics. I will show two spreadsheets on current BDC valuations. I will tell if I perceive BKCC to be a buy, sell or hold based on the current valuations. And I will end with a tangent on whether all this detail work is necessary.
I will start by building a short-term CAGR (Compound Annual Growth Rate) projection for the dividend. Q1-12 over Q1-11 dividend growth was zero while Q1-13 over Q1-12 growth was zero. For the NII, growth was [1.00/1.00] zero in 2012; and is projected to shrink [0.96/1.00] 4% in 2013 and grow back [1.00/0.96] in 2014. There is no room in the Dividend/NII ratio [1.04/0.96] for dividend growth to exceed NII growth in 2013 or 2014. For NAV, 2012 growth was [9.31/9.58] - 2.82%. The consensus analyst five-year forward CAGR found at Yahoo Finance is 5.0%. I am not going to pretend that I can see past 2014 - and there may be growth in those years to come. There is no metric basis for an expectation of dividend growth during the years where I have visibility.
This is the same conclusion reached by BDC Buzz in his article on BKCC.
Now let us talk about risk. BKCC had acceptable EPS projection accuracy in 2012, but well below average accuracy in 2010 and 2011. With a spread of 2013 EPS projections [high estimate minus low, with that result divided by the consensus] at 9.38%, the spread indicates average to slightly above average risk. The portfolio debt/EBITDA and interest coverage ratio metrics are not provided - and that warrants a demerit. The weighted average yield is 11.9% - and this suggests average to below average portfolio risk. With BKCC's debt/NAV at 49.50%, its leverage indicates lower than average risk. The BKCC portfolio is 70.7% in secured debt [notes, first lien and second lien] - which indicates below average risk. BKCC has 0.5% of loans at cost on non-accrual - another very low risk indicator. But we have been guided to expect changes in non-accruals. BKCC has no publicly traded debt to generate a risk assessment based on that attribute. BKCC's cost on its new credit facility is below sector average - suggesting below sector average risk. With investments in 47 portfolio companies, the BKCC portfolio is in the range of average to slightly less than average based on granularity or diversification. The risk qualities of BKCC should produce an average to slightly below average "yield plus CAGR."
This analysis was done to judge the relative safety of the flow of funds that creates NII. It did not include the dividend to EPS ratio in that assessment. That metric is used to judge the safety of the current dividend based on coverage. In the short term, the uncovered dividend is not on the safe side. But dividend cuts tend to happen when the shortfall of NII compared to the dividend is larger than the current ratio. And dividend cuts tend to happen when future NII projections fail to project a return to near coverage. BKCC is only in the light gray area based on those trends.
Current sector valuation spreadsheets
Yield in the spreadsheet below is based on the Q1-13 dividend. Spreadsheet header abbreviations: Div = dividend; EPS = earnings per share; LTM = last twelve months; YTD = year to date. The dividend to EPS ratio is a measure of dividend safety. The dividend to NAV ratio is a measure of safety and efficiency. The last four columns measure the percentage change in the 2013 EPS projection and the change in the price target since the beginning of the year; the change in the Q1-13 dividend from the Q1-12 dividend; and the change in the Q4-12 NAV from the Q4-11 NAV. Some BDCs have already started declaring Q2-13 dividends. MAIN is the only BDC to declare an increase in its Q2-13 dividend.
|Share Price||Div/||Div/||Q4-12||Price||YTD Percent Change||LTM||LTM|
|With the 10 Treasury at 1.91% and sector average yield (on Q1 dividends) at 9% - the spread is 709 bps.|
|The cap weighted ETF BDCS is up 5.21% year to date - with dividends its return is 7.09%.|
|Sector yield and Dividend/EPS ratio filter out the effect of the zero payout ACAS and SAR.|
|Weeding out ACAS and SAR, the average share price gain is 4.49%.|
BDC Earnings Growth & P/E Ratios 03-21
Fiscal and calendar years are not in sync. BDCs that began fiscal 2013 on or before calendar Q3-12 include AINV, FULL, GAIN, GBDC, GLAD, MCC, PSEC, PFLT, and PNNT. The range metric is the high estimate minus the low estimate, with that result dividend by the consensus estimate - and serves as one of several measurements for assessing risk. That average is currently inflated by almost 300 bps due to atypical spreads in the projections for ACAS and GAIN. With the exception of KED, all EPS projections are from Yahoo Finance.
|Earnings / Share||Earn. Growth||P/E Ratios||13 EPS Range|
Summary - There are some things to like about BKCC. The yield is 154 basis points above the sector average. Based on the analyst EPS projection, the 2013 P/E ratio of 10.28 is below the sector average of 10.99. The Price/NAV of 1.06 ratio is below the sector average of 1.10. On those three metrics, BKCC is cheap.
At the current price, BKCC is closer to being a sell than a hold because it fails to rate well on what I believe is the key metric for investing in any dividend producing sector - the "yield plus CAGR" with adjustments for risk. The lack of any prospects for dividend growth should logically result in BKCC having a higher yield and a lower P/E and Price/NAV. I do not believe that BKCC currently sells at a sufficient discount given its relative short comings.
Tangent - How much is enough?
In this two part update on BKCC and in my prior updates on other BDCs, I have done due diligence intensive and metric focused research. Is all this amount of detailed research necessary?
One hops off the due diligence bus at the point of one's own choosing. It strongly appears to me that most retail investors hop off the bus way too early. That early exit is the quickest way to de-earn your hard earned money. The average retail investor knows that one does not earn their wages just by "showing up." So why do they think that their investment dollars are going to outperform just by showing up in the market?
If one is going to invest in individual stocks, then one needs to set a goal of knowing a bit more than the average investor in those sectors where you invest. You want to be able to out-compete your competition. If all you want to do is tie - then buy an index fund. So just how much does your competition know? Let me provide a theory: One can look at the valuations in the sector and deduce a good enough picture of what the market knows. I will first use FULL as an example.
FULL yields 11.85% while the non-cap weighted coverage universe of BDCs I follow (without the inclusion of zero yielding ACAS and SARS) yields 8.97%. What does that mean? It means the market believes that the FULL dividend is less safe and/or less likely to grow compared to the average. Why might it believe that? The Q4-12 NII/share was less than the dividend. And the 2013 EPS (or "NII") projection is less than the dividend. The market knows how to read the headlines - and such simple metrics are headline numbers. This is also evidence that the market is - at least to some degree - "metric aware."
"X" amount of earnings that is growing should sell at a higher price (or P/E) than the same "X" amount of earnings that is relatively stagnant. FULL sold at a 2013 P/E projection of 9.63 while the average BDC sold at a ratio of 11.04. FULL earnings growth (comparing the 2013 projections to the 2012 actual) is 3.85% while the average BDC's earnings are projected by the analysts to grow 6.91%. The dividend per share will not grow if NII/share does not grow. So this valuation difference in P/E ratios is evidence that the market has some CAGR (Compound Annual Growth Rate of the dividend) awareness. And FULL's higher than average yield is also evidence of that CAGR awareness.
When I survey the numbers in the two spreadsheets above, I see an abundance of evidence that the market lives in a "yield plus CAGR" world. Why do KED, MAIN and TCAP sell at such high Price/NAV ratios? Because the market sets their price based on a "yield plus CAGR" basis - and all three merit high CAGR projections. Why do FSC and MCGC sell at such high yields? Because both merit low or negative CAGR projections.
I see an abundance of evidence that the market has a decent amount of risk awareness. Why do NMFC, PFLT and SUNS sell at such low yields? A big part of the reason is the low weighted average yield (and thus lower risk) generated by their lower risk portfolios. Why do HTGC and TICC sell at relatively high yields? The best reason I can see is their venture capital slant of investing in unproven portfolio companies.
A quick look provides evidence that the market is not that dumb. The market is using risk and growth metrics in setting the current valuations.
On the other hand, the market runs on borrowed opinions. Observe the price volatility when rating changes happen. The market allows good CAGRs to sometimes sell at too large a discount. MAIN ended 2011 with one of the lowest yields in the sector - and still significantly outperformed the sector in 2012. And the market cannot calculate its own NII projection - which is another piece of evidence supporting the borrowed opinions theory. The market seldom fully prices in the projections that are expected in tomorrow's news. Prices still predominantly fall on dividend cuts - and predominantly rise on dividend increases - even when the metrics foretold them to be coming. In other words - the market leaves room for us to out compete.
So where do you jump off the due diligence bus? Add this to the truths that should be self evident. You hop off at the point where (1) you stop using borrowed opinions, and use your own. Your opinion should be generated by the performance metrics and current valuations of the stock. You jump off the bus (2) after you can set logical dividend CAGRs in which you can believe - and use that assessment in making a valuation judgment. And for BDCs, you jump off (3) after you can do a logical NII projection.
Life will still come between you and investing success. Opportunities will not wait to reveal themselves until you have the free time to perceive them. Your level of optimism will oscillate with personal events that are unique to you. Families will do what families do - and bring distractions at the best and worst of times. All this emotional baggage is a huge disadvantage. We all have it - but not in equal proportions on any given day.
So what should we do? We build every advantage that we can. For me, it means taking the long ride on the due diligence bus. It means making my buy or not decisions based on the numbers. A "yield plus CAGR" of 12 with an acceptable risk assessment is attractive when life is raining, or when life is sunny. A "yield plus CAGR" at 10 or under is not.
It is my opinion that we live in a world where most investors believe that an hour of due diligence is enough. (If there is research that can confirm or deny this, please let me know.) It is a world where few even know what needs to be learned during due diligence. That leads to a lack of focus and purpose. My due diligence is done to gather the numbers in which to make risk and growth projections. I know in advance what metrics I need to gather. It is a world where too many numbers adds confusion instead of clarity. It is a world where investors fail to put in sufficient effort to make their own opinions, because most of us are going to end up borrowing an opinion in the end. If that is the case, then that can be our advantage.