PennantPark Investment Corporation (PNNT) is a closed-end, externally managed, non-diversified investment company. It is a BDC (Business Development Company). It had its initial public offering on April 24, 2007 - just in time to go through the credit crisis. Unlike most BDCs, it has never had a dividend cut - and has grown its dividend from $0.22/share per quarter to the current $0.28/share. That is an impressive record.
PNNT's founder and CEO Arthur H. Penn has over 25 years of experience in the mezzanine lending, leveraged finance, distressed debt and private equity businesses. He was a co-founder of Apollo Investment Management. Previous employers include UBS and Lehman Brothers. Several years of listening to PNNT conference calls has left me with the impression that he is confident, prudent and conservative. In the conference calls, he talks and acts like a fiduciary. This investor focuses on tangible attributes like performance metrics. I am rarely influenced by the intangibles. Since 2009, I have delegated impression creation to a more intelligent body part. But my gut still trusts Penn.
PNNT has a better than sector average history of generating NII (Net Investment Income) that covers the dividend. Here's most of that history:
|Year||Quarters with coverage||the size of the miss|
|2008||2 out of 4||one cent and three cents|
|2009||4 out of 4|
|2010||2 out of 4||three cents and one cent|
|2011||4 out of 4|
|2012||3 out of 4||a one cent miss|
For Q1-13, NII/share was $0.21 while the dividend was $0.28 - a seven cent miss. That is the biggest NII under performance of the dividend in five years - and twice the size of any of the other misses during that period. The dividend coverage metric is very important. BDCs that fail to cover the dividend strongly tend to cut their dividend. And the size of the Q1-13 miss has temporarily shaken the confidence of the market in PNNT. That perception is based on the post earnings release price performance. But the market makes its impression from the headline numbers. Headline numbers can be deceiving.
Can that seven cents a share or approximate $4.6 million NII/share shortfall be explained by reversible one time events? Maybe it can. Two events alone may explain the miss. Debt issuance costs subtracted three and a half cents from Q1-13 NII. A restructuring of one debt investment that became an equity investment subtracted - according to the conference call - close to five cents from NII. Those two events sum to a negative impact of eight and a half cents. We only needed an explanation for seven. Both of those explanations are one time events.
I want to note that the restructured investment was in PAS Technologies. It was a $16.783 million investment with a 15% cash coupon and a 2% PIK. A 17% yield would only generate TII per quarter of $0.713 million, or $0.0107/share. Prior investment income would have had to be reversed for there to be a five cent charge to current quarter TII. That level of detail is not provided by PNNT. Due to some uncertainty -- I may have only explained four and a half cents of the NII shortfall, and not the hoped for eight and a half. On the other hand, my Q2-13 run rate NII projection (which I will detail later in this article) gives me some confidence that the five cent explanation coming from PAS is the right call.
The feared tax changes of 2013 pulled deal flow from Q1-13 into Q4-12. That fall in deal flow also dropped the generation of pre-payment fee income, and that subtracting approximately half a cent of NII/share. A return to a normal deal flow in Q2-13 will add back that income. Since the end of Q1-13, PNNT has already had one equity investment sale (Realogy) and one potential or upcoming equity sale (Tekelec). It is public information that Tekelec is getting purchased by Oracle (ORCL). PNNT has $8.471 million in Tekelec equity that has a cost basis of $2.477 million. PNNT projects their portfolio equity component will drop from 13% to 10%. Those dollars can be re-invested in interest paying investments to bump up NII. The only bad news I can detect was a bit of pessimism on portfolio growth in the latest conference call.
With a current dividend yield of close to 10%, PNNT is worthy of a fresh look. In this article, I will provide a metric focused look at the Q1-13 earnings; generate a NII/share projection; show the current BDC valuations; and share my assessment as to whether PNNT is a buy, sell or hold.
PNNT Reports NII of $0.2118/share compared to a dividend of $0.28
What It Earned: PennantPark Investment Corporation reported calendar Q1-13 total investment income of $31.057 million [$0.4677/share]. Net investment income was $14.063 million [$0.2118/share]. The net increase in net assets from operations was $26.972 million [$0.4062/share]. Net asset value per share rose was $10.50 compared to $10.38 at the end of Q4-12 and $10.22 at the end of Q3-12.
The ratio of operating expenses to average net assets was 6.44%. All ratios are for the last 6 months. The ratio of credit facility and SBA debenture related expenses to average net assets was 2.40%. The ratio of total expenses to average net assets was 8.84%. The ratio of net investment income to average net assets was 9.33%. The portfolio turnover ratio was 28.80%.
|From non-controlled, non-affiliated investments:|
|From non-controlled, affiliated investments:|
|From controlled, affiliated investments:|
|Total investment income||31.057||32.958||30.805||29.386||26.362||26.839||26.140||22.908||22.711||19.979|
What It Owns: As of March 31, 2013, the PNNT portfolio at fair value totaled $1,132.210 million. It consisted of $291.304 million of senior secured loans (26.1% of the investment portfolio), $249.067 million of second lien secured debt (22.3%), $427.580 million of subordinated debt (38.3%); $24.607 million of preferred (2.2%) and $122.318 million common equity investments (11.0%). The debt portfolio consisted of 67% fixed-rate and 33% variable-rate investments. The overall portfolio consisted of 58 companies with an average investment size of $19.2 million. The weighted average yield on debt investments was 13.5%.
Originations: For the three months ended 3-31-13, PNNT invested in $75.4 million in one new and seven existing portfolio companies with a weighted average yield on debt investments of 13.5%. Sales and repayments of investments for the same period totaled $42.5 million.
My run rate NII projection: With a current 86.8% (a percentage that may be growing) of a current portfolio of $1.115 billion having an average yield of 13.5% - forward Total Interest Income per quarter would be (one fourth of 1.115 times .135) $32.664 million. Forecasting $40 million of portfolio growth that generates 13.3% income for half the quarter, the TII projection grows $0.665 million to $33.329 million. That compares with the "interest income" from Q1-13 of $30.180 million and $28.592 million from Q4-12. For "Other income," I will use a run rate of $2.5 million. That projection can be compared to $0.877 million in Q1-13 and $4.366 million in Q4-12 - and an average of $2.693 million for the last four quarters. That addition produces total TII or revenue per quarter of $35.829 million. This compares to Q1-13 TII of $31.057 million and Q4-12 TII of $33.958 million. The consensus analyst "revenue" projections for Q2-13 are $34.570 million, with a high projection of $36.300 and low of $31.600.
With ending shares of 66.401 million and additional shares per quarter from dividend reinvestment of .700 million -- the projected Q2-13 share count would be 67.101 million. I am projecting that the newly issued debt may cause the NII/TII ratio to fall. For the last four quarters, the NII/TII ratios have been 52.98%; 54.55%; 55.16%; and Q1-13's NII adjusted for debt issuance cost ratio of 53.13%. That new debt was issued the third week of the quarter. With approximately 53% of TII falling to NII, my NII projection would be $18.989 million and the NII/share projection would be $0.2830/share. This compares to the consensus analyst 2013 analyst EPS estimate of $1.11 or $0.2775/quarter. With a low debt/NAV, portfolio growth can happen without share count growth. And with a relatively low cost of funds, portfolio growth will boost NII. NII can grow as the equity component shrinks. But conference call comments about portfolio growth have lowered my expectations. Until I know more, I am putting the odds of dividend growth in 2013 at less than 50%. But NAV growth still causes me to project a mid-term expectation of 1.0% to 1.5% per year dividend growth.
Putting the same information into spreadsheet form, my NII projection looks like this:
|Metric||Fee Income||Interest Income||Totals|
|Formula||average for last 4 quarters||portfolio times yield / 4||port growth times yield / 8||Sum of components|
|Numbers||2.500||1,115 million times .138 / 4||40 million times .133 / 8||33.329|
|Formula||TII times NII/TII||NII/ share count|
|Numbers||53%||.53 times 35.829||18.989 / 67.101||$0.2830/share|
Portfolio Quality Metrics: During the three months ended March 31, 2013, we had one investment restructured after going on non-accrual status. PAS Technologies had $17 million of debt converted into equity. PNNT's portfolio companies had average cash interest coverage of 2.7x, and the average debt / EBITDA through PNNT security of 4.5x.
What It Owes: PNNT had a "credit facility payable" with a weighted average interest rate of 3.00% -- which reduces to 2.75% in 2016. That debt was $171.700 million. SBA debentures payable of $150.000 million had a weighted average interest rate of 3.70%, exclusive of the 3.43% in upfront fees -- or 4.04% after upfront fees. PNNT's 2025 Notes of $71.678 million were issued with a 6.25% yield. Total debt was $392.678 million. With shares outstanding of 66.401 million, the debt/share was $5.9137 and the debt/NAV ratio was 56.32%. Average debt outstanding for the quarter was $352.918 million.
PNNT earning metrics per share:
Total Investment Income $31.057 million [divided by 66.401 million average shares = $0.4677/share]
Interest Expenses = - $3.985 million [- $0.0600/share]
Base Management Fees = - $5.328 million [- $0.0802/share]
Incentive Management Fees = - $3.559 million [- $0.0536/share]
Debt Issuance costs = - $2.438 million [- $0.0367/share]
Total Investment Expenses [including taxes] = - $16.995 million [- $0.2559/share]
Net Investment Income = $14.063 million [$0.2118/share]
Realized appreciation = - $1.831 million [- $0.0267/share]
Unrealized appreciation = $14.740 million [$0.2220/share]
Net Increase in Net Assets Resulting from Operations = $26.972 million [$0.4062/share]
My short-term CAGR (Compound Annual Growth Rate) projection for the dividend: Q2-13 over Q2-12 dividend growth was zero. There has been no change in the NII projections since the earnings release, but I would expect downward adjustments to be made. For the old and stale NII projections, growth was projected at [1.11/1.08] 2.8% in 2013; and was projected to grow [1.16/1.11] 4.5% in 2014. There is no room in the Dividend/NII ratio [1.12/1.11] for dividend growth in 2013. For NAV, growth for the last twelve months was [10.50/10.38] 1.15%. I also use the dividend discount model to solve for a price implied CAGR. That calculation is currently a little below 0%. For the years where I have visibility, I could see PNNT growing the dividend at 1% late in 2013 or early in 2014. But it is just as likely that PNNT will use any NII growth to improve its dividend/NII ratio -- with the appearance of a safer dividend leading to more price appreciation than some anemic growth in the dividend. Over the mid term, dividend growth will be more in line with NAV growth.
My risk assessment of PNNT: There have been no dividend cuts since 2007 -- only dividend growth. PNNT has had good EPS projection accuracy since 2010. With a spread of 2013 EPS projections [high estimate minus low, with that result divided by the consensus estimate] at 9.01%, the spread indicates average risk. For PNNT's portfolio of investments, the weighted average cash interest coverage is 2.7x, and the average debt / EBITDA through PNNT security is 4.5x. Those metrics are very similar to Ares Capital Corporation (ARCC) -- which is perceived as having below sector average risk. The portfolio weighted average yield is 13.5% -- and this important metric suggests above average portfolio risk. With PNNT's debt/NAV at 56.32%, its leverage indicates lower than average risk. The PNNT portfolio is 48% in secured debt -- which indicates average risk. PNNT has no loans at cost on non-accrual -- another very low risk indicator. With investments in 58 portfolio companies, the PNNT portfolio is close to average based on granularity or diversification. The yield-to-maturity numbers for PNNT's publicly traded debt (PNTA) indicates an elevated risk level. PNNT's cost on its credit facility is LIBOR plus 2.75. That is above sector average -- suggesting above sector average risk. Looking at the full menu of risk metrics can often result in a muddy picture. And this picture is muddy with inconsistencies. The risk qualities of PNNT should result in a close to sector average "yield plus CAGR" valuation.
Current BDC valuations:
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, MAIN and TCRD 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|
|With the 10 Treasury at 1.79% and sector average yield (on Q1 dividends) at 8.96% - the spread is 717 bps.|
|The cap weighted ETF BDCS is up 3.90% year to date - with dividends its total return is 7.62%.|
|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 5.49%.|
BDC Earnings Growth & P/E Ratios 05-10
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 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 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|
My valuation assessment of PNNT: A 10.12% yield while the sector average yield is 8.96% makes PNNT attractive. A 1.07 price to NAV while the sector average is 1.11 makes PNNT mildly attractive. Using the 2014 EPS and the 2014 P/E due to an expectation that the 2013 EPS projection will be falling because of the poor NII performance in Q1-13, PNNT has a 9.54 ratio while the sector average is 10.56. That is an attractive valuation. A high mix of SBA debt gives PNNT a cost advantage that results in a slightly better than average NII/TII ratio. That is attractive. Surviving the credit crisis without a dividend cut -- that is really attractive.
I would expect some yield compression as the clock ticks on in 2013 -- and as PNNT returns to having NII that covers the dividend. But after that, share price appreciation should closely match dividend growth. And dividend growth will be low. So an investment in PNNT is not going to make you rich.
I am retired and trying to live off dividends without selling anything. If you are like me, then a 10% yield with low growth will help you to have a portfolio that produces the yield to live on today, as other investments produce the growth that will pay the inflated bills that are yet to come. A yield plus CAGR of 11 is attractive. PNNT is a buy. For those yet to enter retirement, a 10% yield is one large bird in the hand while share price appreciations for other alternatives are distant birds in a bush. Having a more certain 10% return over the next twelve months looks attractive given the S&P's strong year to date performance could indicate weaker performance going forward.