The focus of this article is to estimate Fifth Street Finance Corp.'s (FSC) Q2 2013 net asset value ('NAV'). Determining FSC's NAV will give investors a better sense of what the company's actual worth is currently. Therefore, I feel it is insightful to be able to predict/provide readers with such a figure. After establishing a NAV amount, an investor will be better informed if the current stock price for FSC is overvalued (tendency to sell), undervalued (tendency to buy), or in line (tendency to hold) with their NAV valuation. However, specific factors like a company's growth rate, price-to-earnings (P/E) ratio, and dividend yield all play a factor into an investor's specific buying strategy. This article provides the reader with a specific NAV estimation for Q2 2013 using detailed qualitative + quantitative research (provided below). My specific buy/sell/hold recommendation is within the conclusion paragraph of this article.
General Overview of FSC:
FSC is a business development company which lends to and invests in small and mid-sized companies whose annual revenues are $25-$250 million. Their investment objective is to maximize their portfolio's total return by generating income through their debt investments and also through capital appreciation from equity investments. FSC's fiscal year-end is September 30th of a given year. Therefore, FSC's Q1 2013 quarter ended 12/31/2012.
Historically, FSC has had an attractive dividend yield of 10% -13%. FSC distributes between 90% - 100% of its taxable income each year to stockholders in order to satisfy the requirements of a regulated investment company under the internal revenue code.
FSC's second fiscal quarter (Q2 2013) has recently come to an end (3/31/2013). Before results are provided to the public next month, via their quarterly press release, I would like to project/analyze FSC's Q2 2013 NAV (for the sixth months ended: 3/31/2013). A previous article I wrote laid the groundworks for this NAV prediction. In that article, I projected/analyzed FSC's Q2 2013 income statement. The link to that article is:
Note: Predicting FSC's income statement can be difficult in regards to a few specific accounts. Some examples of difficult accounts to estimate are: 1) fee income; 2) unrealized appreciation (depreciation) on investments; and 3) realized gain (loss) on investments. There are several assumptions + estimates that are used when performing such an analysis. Actual values may differ significantly from the following estimated value,s and all readers should be aware as such. These projections are my personal estimates, and all figures detailed below should not solely be used for an investor's buying or selling decisions.
Due to the fact several figures that are needed to predict/calculate FSC's Q2 2013 NAV come directly from the income statement, I will provide three tables below from my previous article with slight modifications to what information is presented. These tables will show FSC's income statements for Q1 2013 (ACTUAL) + Q2 2013 (ESTIMATED). The other difference in these tables to the tables from my previous article is that I now show an additional column labeled "6 Months Ended" for purposes of predicting a NAV. This new column takes FSC's Q1 2013 (ACTUAL) amounts and adds my Q2 2013 (ESTIMATED) figures. For clarity, I show only these three columns so the reader can see how I came up with the combined figures for the "six month ended" timeframe.
Having provided these three tables above (in particular AGNC's "Q1 A + Q2 E 2013" (ESTIMATE) column), we can now begin to calculate a projected Q2 2013 NAV.
In regards to my NAV table below, FSC provides a similar table that matches the data I have prepared. FSC's table is called "Consolidated Statements in Changes in Net Assets". I recalculate FSC's NAV calculation to ensure all my income statement figures (including various other spreadsheets' amounts) match exactly to what FSC provides/discloses. Therefore, I ensure no variances arise between FSC's figures disclosed and my own.
With the tables I have provided above as a reference, let's take a look at my calculation for FSC's Q2 2013 estimated NAV. All figures mentioned below are for the "6 Months Ended 3/31/2013" timeframe unless otherwise noted. We will look at the following figures (in corresponding order to the NAV calculation (Table 4) shown directly above):
B) Stockholder Transactions
C) Capital Share Transactions
A) Operations: [Net Increase (Decrease) in Net Assets From Operations] [Estimate of $46.5 Million; Range $43.5 - $49.5 Million] [Confidence Within Range = Moderate to High] [See Table 4 Above; Red Reference "A" Next to the Six Months Ended: 3/31/2013 Column]
This figure consists of the following accounts that come directly from the income statement (Table 2 provided at the top of this article): 1) net investment income; 2) net unrealized appreciation (depreciation) on investments; and 3) net realized gain (loss) on investments.
Due to the fact I talked about these accounts in my previous article (link at top of this article), I will not delve into the details on how I obtained these figures. One can look at my previous article to see how I came up with these three accounts for Q2 2013. Q1 2013's actual figures came directly from FSC's 10-Q via their "Consolidated Statement of Operations" table. Also, note the net increase (decrease) in net assets from operations figure (see Table 4) is the same amount as the amount shown within FSC's income statement (see Table 2).
B) Stockholder Transactions: [Net (Decrease) in Net Assets From Stockholder Transactions] [Estimate of ($58.1) Million; Range ($57.1 - $59.1) Million] [Confidence Within Range = High] [See Table 4 Above; Red Reference "B" Next to the Six Months Ended: 3/31/2013 Column]
This is a fairly simple calculation. This is the dividend paid by FSC in Q2 2013 for their outstanding common shares.
The monthly common stock dividend declared and paid in Q1 2013 was $0.0958 per share. This has been the fifteenth consecutive month (fifth consecutive quarter), where AGNC has declared a monthly dividend of $0.0958 per share. The number of common shares outstanding at 12/31/2012 was 105,943,185. I am estimating a monthly dividend reinvestment of 65,000 shares for a total of 195,000 additional shares issued during Q2 2013. These additional shares are issued as part of FSC's dividend reinvestment plan and are added to the number of outstanding shares. In the past, FSC has repurchased shares in the open market to distribute as part of the dividend reinvestment plan (net effect of 0 shares additionally outstanding). However, they have not done this since Q3 2012, and I am predicting they will not do this in Q2 2013. FSC had no equity raises in Q2 2013. Therefore, the following three monthly dividend distribution calculations are determined by the table below:
Therefore, there will be estimated total distributions of $30,466,752 for Q2 2013. For the six months ended 3/31/2013, there will be estimated total distributions of $58,059,752.
C) Capital Share Transactions: [Net Increase in Net Assets From Capital Share Transactions] [Estimate of $155.2 Million; Range $154.7 - $155.7 Million] [Confidence Within Range = High] ] [See Table 4 Above; Red Reference "C" Next to the Six Months Ended: 3/31/2013 Column]
Since there were no equity raises in Q2 2013, the "issuance of common stock, net" figure of $151,334,000 will be unchanged. This amount is just a carried-forward from the 3 months ended column.
For the "issuance of common stock under dividend reinvestment plan", this amount will be the capital raised in relation to my estimated 65,000 shares each month (190,000 shares for the quarter) from the dividend reinvestment plan (discussed earlier). I am estimating January's issuance price per share to be $10.75. For February, I am estimating an issuance price of $10.80 per share. For March, I am estimating an issuance price of $10.85 per share. Due to immateriality, being precise in regards to the exact market price per share on the issuance date is unnecessary. These estimates are in the general range of the market price per share on the issuance dates. Therefore, the calculation for capital raised in relation to the common stock issued under the dividend reinvestment plan is as follows:
Since FSC's stock price was above their NAV throughout Q2 2013, there will not be any common stock shares repurchased.
Remainder of NAV Calculation (see Table 4):
After adding up the three figures above (A through C), the total increase (decrease) in net assets is approximately $146 million for Q2 2013 (shown in the "six months ended: 3/31/2013" column) (reference "D" in table 4 above). Therefore, we can now calculate an estimated Q2 2013 NAV:
Net Assets at Beginning of Period (9/30/2012): $903,570,000
(+) Total Increase (Decrease) in Net Assets: $143,616,261
(=) Net Assets at End of Period: $1,047,186,261
(/) Common Shares Outstanding at 3/31/2013: 106,135,185
(=) Net asset value Per Common Share: $9.87 per share
Conclusion from this article: To sum up all the information I have discussed within this article, I am estimating FSC will report a Q2 2013 (6 months ended: 3/31/2013) NAV of $9.87 per common share. This is a $0.01 per share decrease from Q1 2013's NAV (3 months ended: 12/31/2012). My range for FSC's Q2 2013 NAV is $9.82 - $9.92 per share. This basically unchanged Q2 2013 NAV can be attributed to two factors:
1) One main culprit for FSC's Q2 2013 NAV remaining relatively unchanged are the amounts that I am estimating to be reported in the following accounts: net increase (decrease) in net assets from operations (red reference "A"); net (decrease) in net assets from stockholder transactions (red reference "B"); and issuance of common stock under dividend reinvestment plan (within red reference "C").
Net increase (decrease) in net assets from operations: I am estimating a Q2 2013 amount of 28.7 million for this figure. This number ties into FSC's income statement figure (see Table 2 above).
Net (decrease) in net assets from stockholder transactions: I am estimating a Q2 2013 amount of ($30.6) million for this figure. This number is the difference of ($58.1) million (shown in the "six months ended: 3/31/2013" column) less ($27.6) million (shown in the "three-months ended: 12/31/2012" column) (see Table 4 above).
Issuance of common stock under dividend reinvestment plan: I am estimating a Q2 2013 amount of $2.1 million for this figure. This number is the difference of $3.8 million (shown in the "six months ended: 3/31/2013" column) less $1.7 million (shown in the "three-months ended: 12/31/2012" column) (see Table 4 above).
Therefore, it looks like FSC paid out a Q2 2013 dividend that was slightly more than what I am estimating they report in the net increase (decrease) in net assets from operations figure. This would cause a slight decrease in NAV for Q2 2013. However, the capital they raised from the estimated 195,000 shares issued under their dividend reinvestment plan provided a slight boost to their NAV. This is due to the fact these shares were issued at average share price of $10.80. These shares were accretive to NAV for Q2 2013 by nearly $1.00 per share. After taking all these three figures it play, it caused the estimated $0.01 decrease in NAV for Q2 2013 (relatively unchanged).
2) Another factor in FSC's Q2 2013 NAV being relatively unchanged is the lack of an equity raise occurring this quarter (other than the dividend reinvestment shares just mentioned). Typically, if the current market price is above a company's NAV, then an equity raise will be accretive to a company's overall NAV figure for the quarter. Since there was no equity raise in Q2 2013, there was not a change to NAV in regards to this characteristic.
In April 2013, FSC completed an equity offering of 13.5 million shares at a gross price of $10.85 per share. This will nearly be a $1.00 per share premium to my NAV estimate for Q2 2013 of $9.87 per share (for the 6 months ended: 3/31/2013). This will be accretive to FSC's NAV in Q3 2013 (for the 9 months ended: 6/30/2013).
Side Note in Regards to Buying/Holding/Selling FSC at Current Market Price (As of 4/25/2013):
I feel FSC should continue to trade at a rather slight premium to NAV. One main reason is the yield obtained through ownership of this stock. The current annual yield by owning FSC is approximately 10.5%. The yield on this stock has fluctuated between 10% -13%. This is one reason why investors are attracted to this stock and to the business development company ('BDC') sector in general. More and more investors are looking for a steady stream of dividend income in this low interest environment. For instance, let's say an investor purchases a BDC stock yielding 10% and holds it for 5 years. They then sell it 5 years later at the exact same price that they purchased it. Their capital gain amount is $0. However, through dividends, this investor actually makes a profit of 50% (10% x 5 years). If an investor reinvests their dividends, the profit percentage would be even higher (compounding the dividend). I feel this could be an enticing proposition for most investors looking for a steady stream of income.
FSC currently closed at $10.91 today (4/25/2012). This is a $1.04 premium to my estimated NAV of $9.87 (six months ended: 3/31/2013). This is about a 1.1x price to NAV ratio. At this current price (if I currently owned the stock; which I do not), I would hold the stock and receive the monthly dividends. This market price is too pricey (in my opinion) to currently purchase additional shares in this stock. However, if/as FSC's market price gets closer to my estimated NAV of $9.87 (six months ended: 3/31/2013), I would gain more confidence of purchasing stock in this company.
However, before committing any capital into FSC, I feel an investor should first understand the nature of a company's dividends and how they are derived. Also, I feel an investor should be able to research a particular company and see if they can keep paying the same dividend rate. Perhaps there might be a potential raise in the dividend or a future dividend cut. This is a good transition into my next article containing FSC: dividend sustainability.
Side Note About Dividend Sustainability:
I was originally going to include FSC's dividend sustainability at the end of this article. However, I decided talking about FSC's dividend sustainability here would make this article too lengthy. Also, I feel the topic of dividend sustainability is somewhat different than the purpose of this specific article: projecting FSC's NAV for Q2 2013.
Furthermore, due to the high demand I have received in regards to the topic of dividend sustainability (in particular two stocks I have an interest in), I feel it would be more appropriate to discuss this topic within a separate article.