This article compares BlackRock Kelso Capital (BKCC) to Fifth Street Finance (FSC). Both are Business Development Companies ("BDCs") that lend to small and mid-sized businesses, using similar amounts leverage, currently paying a dividend yield of 11%, and trading at comparable multiples of earnings and NAV.
These are the five general criteria I use to evaluate BDCs:
- Profitability (EPS to cover dividends, growth)
- Risk (diversification, volatility, leverage)
- Payout (sustainable, consistent, growing)
- Analyst Opinions
- Valuation (P/E, PEG, NAV)
For more information about BDCs and how I evaluate them, please see this article.
BlackRock Kelso Capital
- Market Cap: $695 million
- Div Yield: 11.0%
- 2012 Div/EPS: 104%
- P/E: 9.4 (using LTM earnings)
- Price/NAV: 1.01
- Debt/Equity: 0.50
Fifth Street Finance
- Market Cap: $1,121 million
- Div Yield: 10.9%
- 2012 Div/EPS: 107%
- P/E: 9.9 (using LTM earnings)
- Price/NAV: 1.07
- Debt/Equity: 0.56
I recently covered BKCC and FSC in Part 1 and Part 2 in a series called "The Good, The Bad And The Maybe" before they had a chance to report December 2012 financial results. For BKCC, little has changed regarding projected EPS growth especially after missing expectations for 2012 coming in at $1.00 EPS compared to $1.02 with flat to negative growth expected through 2015. FSC met its quarter ended December 2012 EPS of $0.27 and is expected to grow its annual EPS of $1.07 to $1.20 by 2015 eventually covering and surpassing its dividend, unlike BKCC. This is in part due to FSC actively raising both equity and debt capital to grow its portfolio.
BKCC and FSC have portfolios with better than average industry diversification (see charts below). BKCC had 70% in senior secured loans and notes, 16% in unsecured or subordinated debt, and 14% in preferred and common stock, warrants, and limited liability company interests, with 45% of debt investments bearing floating rate loans. FSC had 78% in senior secured loans, 19% in unsecured or subordinated debt, and 3% equity and limited partnership interests, with 71% of debt investments bearing floating rate loans.
At year end they both had similar amounts of leverage, with BKCC's debt to equity ratio of 0.50, which is lower than FSC with 0.56 and both are slightly below the industry average. However, in February BKCC closed a private offering of $100 million in aggregate principal amount of 5.50% unsecured convertible senior notes due 2018 and in March announced it had expanded senior secured revolving credit facility commitments by $75 million. In March FSC announced a public offering of $75 million in aggregate principal amount of its 6.125% senior unsecured notes due 2028.
Non-accrual rates for both companies are low compared to most BDCs, with BKCC at 0.5% of total debt investments on a cost basis and FSC with 1.2% or 0.1% of total debt investments at cost and fair value, respectively.
A couple of the key differences from a risk standpoint between the two companies is FSC has lower volatility ratios and performs better in down markets.
Both companies have higher than average dividend yields near 11% compared to the current average of 9.6%. However, FSC has a higher likelihood of increasing (or at least not cutting) its dividend as projected earnings are expected to rise, compared to BKCC with projected flat earnings through 2015 and insufficient to cover current dividends.
Most analysts rate BKCC a "Hold" with a target price between $9 and $10, and FSC between a "Hold" and a "Buy" with a target price between $11 and $12.
Both companies have lower multiples of earnings and NAV than the average BDC, but BKCC is valued slightly lower on both.
Below is an oversimplified table ranking BKCC and FSC giving them a score between 0 and 10 (10 being the best) relative to the 25 BDCs I have reviewed. In reality I use different weightings for almost 100 data points on each company and my personal rankings (based on my risk/return comfort) are close to these but far from exact. Keep in mind that the rankings for the 'payout' category take into account the ability to sustain current distribution levels or potentially grow, as well as the overall rate.
The 11% dividend yield is attractive, but both companies have cut distributions in the last two years to align with earnings. Earnings for FSC are projected to surpass its current dividend payout unlike BKCC. Both companies have healthier than average portfolio mixes with BKCC having better industry diversification and FSC with a safer asset class mix. The current leverage ratios for both are decent but BKCC is using only debt to finance growth compared to FSC which has recently been raising both debt and equity capital. FSC is much safer from a volatility standpoint and hopefully will continue to perform better than average in down markets. BKCC has better valuation multiples, except for PEG, most likely because investors consider it a higher risk profile.
Other contributors such as Factoid in this article have pointed out similar issues with BKCC and in my last review of BKCC I considered it one of 'The Bad' BDCs but revised it to the low end of 'The Maybe' category and FSC is still a solid 'Maybe' until it can cover its dividend.
- Part 22 - Prospect Capital (PSEC)
- Part 21 - PennantPark Floating Rate Capital (PFLT)
- Part 20 - American Capital (ACAS)
- Part 19 - Full Circle Capital (FULL)
- Part 18 - Solar Senior Capital (SUNS)
- Part 17 - Gladstone Capital (GLAD)
- Part 16 - Fidus Investment (FDUS)
- Part 15 - Horizon Technology Finance (HRZN)
- Part 14 - TICC Capital (TICC)
- Part 13 - TCP Capital (TCPC)
- Part 12 - Triangle Capital (TCAP)
- Part 11 - New Mountain Finance (NMFC)
- Part 10 - THL Credit (TCRD)
- Part 9 - Golub Capital (GBDC)
- Part 8 - KCAP Financial (KCAP)
- Part 7 - Ares Capital (ARCC)
- Part 6 - Hercules Technology Growth Capital (HTGC)
- Part 5 - Solar Capital (SLRC)
- Part 4 - PennantPark Investment (PNNT)
- Part 3 - Apollo Investment (AINV)