Why BlackRock Kelso Capital Had A Disappointing First Quarter

May. 6.13 | About: BlackRock Kelso (BKCC)

BlackRock Kelso Capital (NASDAQ:BKCC) is a BDC (Business Development Company) that provides middle-market companies with flexible financing solutions, including senior and junior secured, unsecured and subordinated debt securities and loans, and equity securities. BlackRock Kelso Capital was formed in 2005 by management, BlackRock and principals of Kelso & Company. The BKCC IPO was in June of 2007 at a price of $14.90 and a dividend of $0.42/share/quarter. BKCC closed Friday at a price of $9.83 and paying a dividend of $0.26/share/quarter.

In this article, I will present data from the BKCC Q1-13 earnings release from May 2, 2013 and discuss reasons for the underperformance compared to analyst projections. I will produce two spreadsheets that show the current BDC sector valuations. I will show how I produce a short-term dividend growth projection and a risk assessment. And I will tell if I perceive BKCC to be a buy, sell or hold.

BKCC Reports NII of $0.1761/share compared to a dividend of $0.26

What They Earned: BlackRock Kelso Capital Corporation reported for Q1-13 Total investment income of $31.130 million ($0.4230/share) and Net Investment income of $12.964 million ($0.1761/share). The NII/TII ratio was 41.64% for the quarter and 50.01% for full-year 2012 compared to 55.42% for 2011. Net increase in net assets from operations was $29.797 million ($0.4049/share). Fee income was $2.762 million compared with $4.395 million last quarter. For the prior last 4 quarters, fee income was $20.724 million - or an average of $5.2 million per quarter. PIK income was approximately 7.3% of interest income earned in Q1-13 compared to 4.5% earned in 2012. The Net Asset Value per share was $9.47 compared with $9.31 at the end of Q4-12; $9.55 at the end of Q3-12; $9.61 at the end of Q2-12; and $9.59 at the end of Q1-12.
For the 3 months ending 3-31-13, the ratio of operating expenses to average net assets was 7.66% while the ratio of interest and other debt-related expenses to average net assets of 3.01% resulting in total expenses to average net assets of 10.67% (compared to 8.22% in 2011; 7.40% in 2010; and 9.29% in 2009). The ratio of net investment income to average net assets was 7.61% (compared to 10.22% in 2011; 9.68% in 2010; and 14.47% in 2009). Portfolio turnover was 10%.


Q1-13 Q4-12 Q3-12 Q2-12 Q1-12 Q4-11
Interest income
Non-controlled, non-affiliated 24,832,109 26,994,492 27,543,637 28,049,784 26,209,176 29,449,310
Non-controlled, affiliated 948,005 911,860 1,037,387 1,484,764 1,531,179 1,680,307
Controlled investments 2,543,547 3,065,887 3,071,070 1,777,957 1,652,740 3,249,435
Total interest income 28,323,661 30,972,239 31,652,094 31,312,505 29,393,095 34,379,052
Fee income:
Non-controlled, non-affiliated 2,741,659 4,337,447 8,369,140 3,708,563 3,379,612 739,177
Non-controlled, affiliated 0 0 602,344 66,682 66,682 149,040
Controlled investments 20,747 57,522 57,679 39,245 39,246 50,000
Total fee income 2,762,406 4,394,969 9,029,163 3,814,490 3,485,540 938,217
Dividend income:
Non-controlled, non-affiliated 43,435 30,344 38,845 339,282 328,030 649,428
Non-controlled, affiliated 0 2,500,000 0 0 0 21,898
Controlled investments 0 0 0 0 0 0
Total dividend income 43,435 2,530,344 38,845 339,282 328,030 671,326
Total investment income 31,129,502 37,897,552 40,720,102 35,466,277 33,206,665 35,988,595

Total investments at fair value 1,022,771,100 1,061,597,541 1,093,978,117 1,165,543,114 1,095,390,307 1,048,952,442

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The $2.5 million dividend from "Non-controlled, affiliated" investments in Q4-12 related to BKCC's investment in M&M Holdings. BKCC reported that they have "no insight as to if this will continue in 2013." Q3-12 had unusually high fee income due to one-time events.

What They Own: At 3-31-13, BKCC's portfolio consisted of 44 portfolio companies with a fair value of $1,022.771 million - and was invested 21.4% ($218.769 million) in senior secured notes; 6.83% ($69.836 million) in unsecured debt; 7.2% ($73.345 million) in subordinated debt securities; 18.5% ($188.977 million) in first lien senior secured loans; 30.3% ($310.391 million) in second lien senior secured loans; 0.7% ($6.863 million) in preferred stock; 7.7% ($78.737 million) in common stock; 5.7% ($57.977 million) in partnerships; and 1.7% ($17.877 million) in equity/warrants. BKCC provided a different breakdown in the 10-Q. That content: "49% in senior secured loans, 21% in senior secured notes, 16% in equity investments, 14% in unsecured or subordinated debt securities, and less than 1% in cash and cash equivalents. "Approximately 49.6% of BKCC's debt investments bore interest based on floating rates, such as LIBOR, the Federal Funds Rate or the Prime Rate, and 50.4% bore interest at fixed rates.

The weighted average yield of the debt and income producing equity securities in their portfolio at fair value was 12.4%. The weighted average yield on senior secured loans was 11.5%. The weighted average yield on other debt securities at fair value was 13.6%. Yields exclude common equity investments, preferred equity investments with no stated dividend rate, short-term investments and cash and cash equivalents.

Originations: During Q1-13 BKCC invested $46.0 million. Sales, repayments and other exits of investment principal totaled $104.2 million.

What They Owe: In January 2011, BKCC closed a private placement issuance of $158 million in five-year, senior secured notes with a fixed interest rate of 6.50% and a maturity date of January 18, 2016. On February 19, 2013, BKCC closed a private offering of $100 million in 5.50% unsecured convertible senior notes due 2018. Credit facility pricing at year end was at LIBOR + 2.50%. Debt at the end of Q1-13 was $17.000 million from the credit facility; $113.796 million from the convertible notes; and $175.000 million in secured notes. This sum of $305.796 million divided by ending shares outstanding of 75.386 million produces a Debt/share of $4.0564 and a Debt/NAV ratio of 42.83%. BKCC's average outstanding debt balance during the quarter was $329,905,368. Commitment fees incurred for the unused portion of the credit facility was $306,015. The expense for the amortization of debt issuance costs for the quarter was $366,006. The weighted average annual interest cost for the three months ended March 31, 2013 was 5.45%. The BKCC 10-K noted that the 2012 average debt outstanding was $381.451 million - and the weighted average cost of debt was 4.90%.

Portfolio Quality Metrics: The 10-Q, unlike prior quarters, failed to report BKCC's investments that were on non-accrual status. In the Q4-12 conference call, it was stated that BKCC had no investments on non-accrual at year end. Since year-end, BKCC stated that they had "been actively engaged in the restructuring of two portfolio companies, at least one of which we anticipate will result in a non-accrual, as of the end of our current first quarter of 2013." In the Q1-13 call, BKCC stated that neither of the two restructuring transactions had been completed by the end of the quarter. But one completed its restructuring in April. Both of the two companies had "earned" their interest payments in Q1-13. BKCC's failure to say that they "paid" their interest payments bothers me. BKCC fails to disclose debt-to-EBITDA and interest coverage ratio metrics for its portfolio companies.

BKCC per share stats
BKCC has a current dividend of $0.26/share
Total Investment Income $31.130 million (divided by 73.597 million average shares = $0.4230/share)
Interest Expenses = - $4.758 million (- $0.0646/share)
Base management fee = - $5.350 million (- $0.0727/share)
Incentive fees paid to management = - $5.264 million (- $0.0715/share)
Total Investment Expenses = - $18.165 million (- $0.2468/share)
GAAP Net Investment Income = $12.964 million ($0.1761/share)
Realized gain (loss) on investments = $0.213 million ($0.0029/share)
Unrealized appreciation = $16.620 million ($0.2258/share)
Net Increase in Net Assets Resulting from Operations = $29.797 million ($0.4049/share)
Diluted shares outstanding were 78.356 million; diluted NII was $0.1654/share and diluted earnings were $0.3803/share

Why BKCC under-performed analyst projections: The consensus analyst forecast of Q1-13 NII/share was $0.27/share while revenue projections were for $34.560 million. A falling amount of investments along with falling fee and dividend income caused the decrease in TII or revenue. Unrealized appreciation occurs below the line of net investment income while the management fees generated by those gains are subtracted from NII. BKCC reported that $3.7 million of their incentive was attributable to those unrealized gains. That extra $3.7 million was subtracted from NII because good things happened. $3.7 million works out to five cents per share.

Due to a lower amount of sales and originations, fee income was lower than in any quarter of 2012. The fall in dividend income compared to Q4-12 was expected. BKCC had incurred the expenses to raise $115 million in new debt while its investment portfolio shrank. BKCC expects to grow the debt portfolio - and that will eventually add to TII and NII. At the same time, BKCC noted in their conference call that some of their equity positions may be in a position to begin paying dividends.

My top-down net investment income projection for BKCC: BKCC start with a lower portfolio of investments and the NII/TII ratio is falling due to higher expenses with an added debt load. The trend in fee and dividend income is falling. At the same time, the weighted average yield is rising. Approximately 83% of a portfolio of $1.023 billion (or $849 million) is generating income. There is no current trend for portfolio growth. The top down formula would forecast (849 times .124 dividend by four) $26.319 million in interest income. Using the same formula which I detailed in a prior update, my NII projection looks like this:

TII Calculation
Metric Fee Income Dividend Income Interest Income Totals
Formula average for last 4 quarters average for last 4 quarters portfolio times yield / 4 Sum of components
Numbers 5.000 0.400 849 million times .124 / 4 31.719

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NII Calculation
Metric NII/TII Ratio NII NII/share Result
Formula provided above TII times NII/TII NII/ share count
Numbers 47% .47 times 31.719 14.908 / 75.386 $0.1977/share

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I am expecting significant adjustments to the analyst forecasts that have yet to be reflected in the projections currently shown at Yahoo Finance. The current Q2-13 revenue projection is $36.020 million and the current NII or EPS projection is $0.27/share. The lumpy nature of fee and dividend income results in quarterly projections that tend to lack accuracy. Your focus needs to be on the annual projection. My Q2-13 would indicate that BKCC is currently headed towards a 2013 NII of a bearish $0.80/share to a bullish $0.86/share if portfolio growth occurs. The current analyst consensus forecast is for $0.96/share with a high forecast of $1.01 and a low of $0.89.

My risk and growth projections for BKCC: The BKCC portfolio is high in secured debt, suggesting lower-than-average risk. BKCC's lower use of leverage indicates lower-than-average risk. BKCC has low non-accrual assets, suggesting very low risk. But the April restructuring of one portfolio company, with a second portfolio company in negotiation, indicates that the low non-accrual numbers are not painting an accurate picture of portfolio risk. With a weighted average yield on its portfolio of 12.4%, BKCC is approaching sector average on that metric. With investments in only 44 portfolio companies, BKCC has a less than granular portfolio, suggesting higher-than-average risk. But when EPS projection accuracy starts to go bad, my risk assessment rises. And when NII is less than the dividend for two straight quarters, my risk assessment goes up again. There continues to be no metric basis for an expectation of dividend growth during the years where I have visibility. BKCC's current performance puts the dividend in some degree of danger of being cut. BKCC has cut its dividend twice since 2008 when the dividend was not covered for NII/share. In summation, BKCC is a near-average risk BDC with much lower-than-average growth potential. It should sell at a noticeably higher yield, a lower P/E, and a lower price to NAV ratio than other BDCs.

Before I show my valuation assessment of BKCC, let us first look at current BDC sector performance and valuations based on pricing from 5-03-13.

BDCs 05-03-13

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. KED and MAIN are the only BDCs to declare an increase in their Q2-13 dividend.


Share Price Div/ Div/ Q4-12 Price YTD Percent Change LTM LTM
Company 1-01 05-03 Yield EPS NAV NAV NAV Price Pr+Div EPS Target Div NAV

American Cap ACAS 12.02 14.49 0.00 0.0 0.0 17.84 0.81 20.55 20.55 7.62 21.79 na 28.62
Apollo Invest AINV 8.36 8.77 9.12 96.4 9.8 8.14 1.08 4.90 9.69 -5.68 6.64 -28.57 -0.25
Ares Capital ARCC 17.50 18.12 8.39 92.1 9.5 16.04 1.13 3.54 5.71 -0.60 2.96 2.70 4.56
BlackRock BKCC 10.06 9.83 10.58 108.3 11.2 9.31 1.06 -2.29 2.88 -4.95 2.53 0.00 -2.82
Fidus Invest FDUS 16.45 18.71 8.12 91.6 9.9 15.32 1.22 13.74 16.74 -2.92 9.46 11.76 2.82
Fifth St FSC 10.42 10.98 10.47 100.8 11.6 9.88 1.11 5.37 8.96 2.70 2.16 0.00 -0.10
Full Circle FULL 7.43 7.75 11.92 114.1 11.5 8.03 0.97 4.31 8.35 0.00 0.00 0.00 -9.98
Gladstone Inv GAIN 6.96 7.23 8.30 98.4 6.9 8.65 0.84 3.88 6.75 10.91 -11.11 0.00 -9.71
Golub Cap GBDC 15.98 17.65 7.25 99.2 8.7 14.66 1.20 10.45 12.45 0.78 -2.47 0.00 0.89
Gladstone Cap GLAD 8.16 8.98 9.35 98.8 9.1 9.19 0.98 10.05 13.48 -1.16 -1.33 0.00 -7.17
Horizon HRZN 14.92 14.48 9.53 96.5 9.1 15.15 0.96 -2.95 -0.64 -5.92 -5.53 -23.33 -10.30
Hercules HTGC 11.13 13.41 7.46 90.9 10.3 9.75 1.38 20.49 22.73 0.92 9.77 8.70 -0.81
Kayne And KED 24.44 26.22 6.56 81.9 7.2 23.74 1.10 7.28 9.04 9.38 3.80 10.26 3.17
Kohlberg KCAP 9.19 10.66 9.01 90.6 12.2 7.85 1.36 16.00 18.61 3.92 11.89 33.33 0.00
Main St. MAIN 30.51 29.37 6.13 87.4 9.7 18.59 1.58 -3.74 -1.77 0.98 9.62 11.11 22.38
Medley Cap MCC 14.56 15.22 9.46 96.0 11.3 12.69 1.20 4.53 7.01 3.45 8.12 28.57 0.95
MCG Capital MCGC 4.60 5.32 9.40 104.2 9.7 5.18 1.03 15.65 18.37 4.35 2.59 -26.47 -8.32
New Mountain NMFC 14.90 15.16 8.97 98.6 9.7 14.06 1.08 1.74 4.03 1.47 0.00 6.25 3.38
NGP Capital NGPC 7.22 6.52 9.82 97.0 6.7 9.57 0.68 -9.70 -5.26 -15.38 -3.33 -11.11 3.35
Prospect PSEC 10.87 11.05 11.95 85.7 12.2 10.81 1.02 1.66 5.60 3.36 6.65 8.72 1.12
Pennant Float PFLT 12.70 14.12 7.44 90.5 7.5 13.99 1.01 11.18 13.87 5.45 5.36 16.67 2.27
Pennant Cap PNNT 10.99 11.43 9.80 100.9 10.8 10.38 1.10 4.00 9.10 -1.77 1.71 0.00 2.06
Saratoga SAR 15.40 17.99 0.00 0.0 0.0 21.75 0.83 16.82 16.82 -2.11 0.00 na -10.57
Solar Cap SLRC 23.91 23.74 10.11 99.6 11.6 20.70 1.15 -0.71 4.31 -6.23 3.77 0.00 -5.99
Solar Senior SUNS 18.66 19.15 7.36 108.5 7.7 18.33 1.04 2.63 5.08 -8.45 2.63 30.56 2.00
Medallion TAXI 11.74 14.71 5.98 77.9 8.8 9.99 1.47 25.30 27.17 6.60 15.04 10.00 3.20
Triangle Cap TCAP 25.49 27.83 7.76 93.5 14.1 15.30 1.82 9.18 11.30 2.21 15.22 14.89 4.22
THL Credit TCRD 14.79 15.27 8.64 93.6 10.0 13.20 1.16 3.25 5.48 -1.40 6.82 13.79 -0.30
TICC Cap TICC 10.12 10.04 11.55 100.9 11.7 9.88 1.02 -0.79 2.08 -5.74 -0.18 7.41 6.24

Sector Average 8.91 96.1 10.0 1.12 6.77 9.60 0.06 4.30

With the 10 Treasury at 1.75% and sector average yield (on Q1 dividends) at 8.91% - the spread is 716 bps.
The cap weighted ETF BDCS is up 4.26% year to date - with dividends its total return is 7.98%.
Sector yield, Dividend/NAV and Dividend/EPS ratio filter out the zero payout ACAS and SAR.
Weeding out ACAS and SAR, the average share price gain is 5.89%.
Click to enlarge

BDC Earnings Growth & P/E Ratios 05-03

Fiscal and calendar years are not in sync. BDCs that began fiscal 2013 on or before calendar Q3-12 include Apollo Investment (NASDAQ:AINV), Full Circle Capital (NASDAQ:FULL), Gladstone Investment (NASDAQ:GAIN), Golub Capital (NASDAQ:GBDC), Gladstone Capital (NASDAQ:GLAD), Medley Capital (NYSE:MCC), Prospect Capital (NASDAQ:PSEC), PennantPark Floating Rate Capital (NASDAQ:PFLT), and PennantPark Investment (NASDAQ:PNNT). The range metric is the high estimate minus the low estimate, with that result divided 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 American Capital (NASDAQ:ACAS) and GAIN. With the exception of Kayne Anderson Energy Development (NYSE:KED), all EPS projections are from Yahoo Finance.


Earnings / Share Earn. Growth P/E Ratios 13 EPS Range
Co. 2008 2009 2010 2011 2012 2013 2014 11-12 12-13 13-14 2012 2013 2014 High Low Range

ACAS 242 61 62 126 116 113 1.22 -7.94% -2.59% 7.96% 12.49 12.82 11.88 124 92 28.32%
AINV 180 148 126 99 88 83 0.85 -11.11% -5.68% 2.41% 9.97 10.57 10.32 85 79 7.23%
ARCC 142 128 132 156 165 165 1.72 5.77% 0.00% 4.24% 10.98 10.98 10.53 187 156 18.79%
BKCC 176 139 101 100 100 96 1.00 0.00% -4.00% 4.17% 9.83 10.24 9.83 101 93 8.33%
FDUS 0 0 0 163 154 166 1.82 -5.52% 7.79% 9.64% 12.15 11.27 10.28 173 160 7.83%
FSC 130 127 95 101 107 114 1.16 5.94% 6.54% 1.75% 10.26 9.63 9.47 122 107 13.16%
FULL 0 0 0 84 78 81 0.81 -7.14% 3.85% 0.00% 9.94 9.57 9.57 81 81 0.00%
GAIN 79 62 48 73 62 61 0.61 -15.07% -1.61% 0.00% 11.66 11.85 11.85 62 22 65.57%
GBDC 0 0 0 116 115 129 1.39 -0.86% 12.17% 7.75% 15.35 13.68 12.70 129 127 1.55%
GLAD 135 100 84 88 91 85 0.89 3.41% -6.59% 4.71% 9.87 10.56 10.09 92 78 16.47%
HRZN 0 0 0 150 141 143 1.49 -6.00% 1.42% 4.20% 10.27 10.13 9.72 168 123 31.47%
HTGC 123 125 80 91 97 110 1.24 6.59% 13.40% 12.73% 13.82 12.19 10.81 118 107 10.00%
KED 135 127 125 136 189 210 2.27 38.97% 11.11% 8.10% 13.87 12.49 11.55 210 210 0.00%
KCAP 150 104 53 70 89 106 1.09 27.14% 19.10% 2.83% 11.98 10.06 9.78 112 97 14.15%
MAIN 115 90 100 169 201 206 2.21 18.93% 2.49% 7.28% 14.61 14.26 13.29 216 193 11.17%
MCC 0 0 0 56 125 150 1.57 123.21% 20.00% 4.67% 12.18 10.15 9.69 160 144 10.67%
MCGC 93 60 60 53 25 48 0.54 -52.83% 92.00% 12.50% 21.28 11.08 9.85 50 42 16.67%
NMFC 0 0 0 56 135 138 1.41 141.07% 2.22% 2.17% 11.23 10.99 10.75 140 136 2.90%
NGPC 79 57 54 73 55 66 0.72 -24.66% 20.00% 9.09% 11.85 9.88 9.06 74 58 24.24%
PSEC 191 187 109 109 163 154 1.29 49.54% -5.52% -16.23% 6.78 7.18 8.57 159 145 9.09%
PFLT 0 0 0 5 101 116 1.16 1920.00% 14.85% 0.00% 13.98 12.17 12.17 122 111 9.48%
PNNT 88 109 109 125 108 111 1.16 -13.60% 2.78% 4.50% 10.58 10.30 9.85 115 105 9.01%
SAR 1300 1640 457 215 186 186 1.86 -13.49% 0.00% 0.00% 9.67 9.67 9.67 186 186 0.00%
SLRC 0 200 208 225 220 241 2.58 -2.22% 9.55% 7.05% 10.79 9.85 9.20 251 227 9.96%
SUNS 0 0 0 63 131 130 1.43 107.94% -0.76% 10.00% 14.62 14.73 13.39 140 117 17.69%
TAXI 86 56 64 101 121 113 1.18 19.80% -6.61% 4.42% 12.16 13.02 12.47 116 108 7.08%
TCAP 154 161 158 206 216 231 2.46 4.85% 6.94% 6.49% 12.88 12.05 11.31 249 216 14.29%
TCRD 0 0 0 104 138 141 1.50 32.69% 2.17% 6.38% 11.07 10.83 10.18 150 135 10.64%
TICC 91 49 89 94 112 115 1.18 19.15% 2.68% 2.61% 8.96 8.73 8.51 132 113 16.52%

BDC Average 81.54 7.51 4.53 11.90 11.07 10.56 13.53
Click to enlarge

My valuation assessment for BKCC: BKCC sells at a yield of 10.58% compared to the sector average for dividend paying BDCs of 8.91%. BKCC is paying out 8.3% more than the analyst 2013 EPS or NII projection while the average BDC is paying out 3.9% less in dividends than the NII projection. BKCC sells at a price to net asset value ratio of 1.06 while the sector average is 1.12. BKCC sells at a 2013 analyst projection based P/E ratio of 10.24 while the sector average ratio is 11.07.
I would strongly suggest that you not be tempted by BKCC's current seductive yield or its other low valuation ratios. EPS projections are more likely to be cut than grow. The dividend has some chance of being cut. BDCs sell at logical "yield plus projected dividend growth" metrics. BKCC would need to sell at an even higher yield before I would be tempted. And I would need to see the Q2-13 results before I might begin to project that the current dividend is relatively safe.

Disclosure: I am long ARCC, MAIN, PNNT, TCAP. 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.