PennantPark Floating Rate Capital (PFLT) had its initial public offering on April 7, 2011 and closed that day at $13.40. PFLT closed Monday at $14.31 and with a yield of 7.34%. The current monthly dividend is $0.0875/share compared to the beginning dividend of $0.05/share. Last twelve month dividend growth is 9.375% [$0.0875/$0.0800]. Like PennantPark Investment Corporation (PNNT), it is externally managed by PennantPark Investment Advisers - a firm with over 20 years of experience in the mezzanine lending, leveraged finance, distressed debt and private equity businesses. (My Q1-13 update on PNNT) PFLT has targets of having 80% of its portfolio invested in Floating Rate Loans - and to have 65% of its portfolio invested in senior secured loans. This should give PFLT a portfolio that is safer than the average BDC (Business Development Company).
With a relatively safe dividend that has prospects of future dividend growth, PFLT is worthy of a 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 PFLT is a buy, sell, or hold.
PFLT Reports NII of $0.2363 compared to a dividend of $0.2550
What It Earned
PennantPark Floating Rate Capital reported calendar Q1-13 total investment income of $4.140 million ($0.5872/share). Net investment income - which was hurt by one-time events - was $1.666 million ($0.2363/share). When a BDC does mark-to-market on its credit facility, it is obligated under GAAP to take the facility adjustment fees upfront. PFLT had $0.500 million ($0.0709/share) of such fees in Q1-13. With realized and unrealized appreciation of $1.975 million, the Net Increase in Net Assets from Operations totaled $3.206 million [$0.4547/share]. Net asset value per was $14.10 compared to $13.99 at the end of Q4-12 and $13.98 at the end of Q4-12. There is no mention of "PIK income" in the earnings release or 10-Q. PFLT does have five investments listed as paying PIK and "cash" interest.
For the last six months, PFLT's ratio of operating expenses to average net assets was 5.68%. The ratio of credit facility related expenses to average net assets was 2.37%. Total expenses to average net assets were 8.05%. The ratio of net investment income to average net assets was 7.27%. Portfolio turnover ratio was 85.12%.
|Total Investment Income||4,139,877||3,962,673||2,467,028||3,200,702||2,943,702||2,467,028|
|Net Investment Income||1,665,925||2,058,873||1,374,899||1,846,209||1,544,900||1,374,899|
What It Owns
As of 03-31-13, PFLT's portfolio totaled $183.870 million and consisted of $159.682 million of senior secured loans (86.8%); $10.347 million of second lien secured debt (5.6%); $11.904 million of subordinated debt (6.5%); and $1.936 million (0.1%) in preferred and common equity investments. PFLT's portfolio consisted of 8x% variable-rate investments (including 8x% with a LIBOR or prime floor) and 1x% fixed-rate investments. Overall, the portfolio had unrealized depreciation of $0.3 million. The portfolio consisted of 63 portfolio companies (64 last quarter) with an average investment size of $2.9 million, a weighted average yield on debt investments of 8.8% compared with 8.9% last quarter.
For the three months ended 03-31-13, PFLT purchased $45.1 million in 16 new and four existing portfolio companies. Sales and repayments of investments totaled $43.9 million.
My run rate NII projection
With approximately 98.9% of a portfolio of $184 million having an average yield of 8.8% - forward total interest income per quarter would be $4.003 million. That compares with the 'interest' income from Q1-13 of $3.976 million and Q4-12's $3.963 million. Quarterly portfolio growth is a tough call. The LTM run rate is close to $10 million - and that would produce another $0.110 million in TII. But net growth has been slowed by above trend redemptions. I will be a tad bullish and project $20 million growth with $0.220 million added to TII - but a significant reduction in redemptions could add significantly more to portfolio growth. For "Other" income, I will use an annual run rate of $0.142 million/quarter (the LTM average - but historical evidence says other income will be lumpy). This produces a TII total per quarter of $4.365 million. This compares to consensus analyst 'revenue' projections for Q2-13 of $3.870 million - with a range from $3.280 million to $4.460 million.
The secondary offering of 3 million shares in late March should result in lower credit facility use. In Q4-12, when credit facility debt ended at $85.775 million, interest expenses were $0.471 million. For Q2-13 when credit facility debt is starting at $34.200, interest expenses may be half the Q4-12 amount. Using the TII from the above projection, the new credit facility expense projection; and using total expenses minus the Q4-12 credit facility expense to create a "other expenses" run rate, the result is the following:
Total investment income = $4.365 million or $0.4431/share
Interest expense = $0.235 million or $0.0239/share
Other expenses = $1.500 million or $0.1523/share
Total expenses = $1.735 million or $0.1761/share
Net investment income = $2.630 million or $0.2670/share
The consensus analyst Q2-13 EPS projection is for $0.28/share. A quick reminder: Analyst EPS projections are NII projections. I had to make to some bullish projections to get to $0.2670/share - so I believe the analyst projection is overly bullish. The full year 2013 EPS is $1.16 or $0.2900/share/quarter. As PFLT grows its portfolio and uses inexpensive credit facility debt, NII/share should modestly grow. I am comfortable with the full year forecast.
The 2014 analyst EPS estimate also is $1.16. It is my theory that PFLT lacks the attributes to accretively grow NII. Those attributes are: a high price to NAV so equity raises are more accretive; SBA (Small Business Administration backed) debt so that a raise debt capital is more accretive to the dividend; a higher NII/TII ratio so that increased TII adds more to NII. A needed diversification of credit capital could lower PFLT's NII/TII ratio. So I am not surprised by the lack of growth in the 2014 projection.
Portfolio Quality Metrics
Non-accrual stats were not provided - but there were no footnotes of non-accruals in the 10-Q list of assets. Portfolio companies had an average cash interest coverage of 3.4x. Portfolio companies had an average debt / EBITDA through PFLT security of 3.6x. (The source for both stats was the investment presentation of 3-31-13.) Those are atypically strong credit metrics for BDC portfolio companies.
What It Owes
With long-term debt ("credit facility payable") of $34.200 million and shares outstanding of 9.851 million, the Debt/share was $3.4717 and the Debt/NAV ratio was 24.62%. Interest is charged on the credit facility balance at the rate of LIBOR + 200 bps.
PFLT per share numbers
Total Investment Income $4.140 million (divided by 7.051 million average shares = $0.5872/share)
Base Management Fee = - $0.456 million (- $0.0644/share)
Incentive Fee = - $0.562 million (- $0.0797/share)
Interest expense = - $0.495 million (- $0.0702/share)
Credit Facility amendment costs = - $0.500 million (- $0.0709/share)
Excise Tax = - $0.033 million (- $0.0047/share)
Total Investment Expenses = - $2.474 million (- $0.3509/share)
Net Investment Income = $1.666 million ($0.2363/share)
Core NII = NII + Credit Fee = $2.166 million ($0.3072/share)
Realized Appreciation = $0.435 million ($0.0617/share)
Unrealized Appreciation = $1.540 million ($0.2184share)
Net Increase in Net Assets Resulting from Operations = $3.206 million ($0.4547/share)
My short-term CAGR (Compound Annual Growth Rate) projection for the dividend
Q2-13 over Q2-12 dividend growth was ($0.0875/$0.0800) 9.375%. 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 (1.16/1.01) 14.85% in 2013; and was projected to grow (1.16/1.16) 0% in 2014. There is plenty of room in the Dividend/NII ratio (1.05/1.16) for dividend growth in 2013. For NAV, growth for the last twelve months was (14.10/14.12) -0.14%. I also use the dividend discount model to solve for a price implied CAGR. That calculation is currently 1.23%. For the two years where I have some visibility, I could see PNNT growing the dividend at 5%/year - even with flat NAV and NII growth. But without NII growth, that trend should slow in 2015 and end in 2016. My five year dividend CAGR projection would range from a conservative 1.5% to a bullish 2% - with that growth front loaded.
My risk assessment of PFLT
PFLT has had good EPS projection accuracy since its IPO. With a spread of 2013 EPS projections (high estimate minus low, with that result divided by the consensus estimate) at 9.48%, the spread indicates average risk. For PFLT's portfolio of investments, the weighted average cash interest coverage is 3.4x, and the average debt / EBITDA through PNNT security is 3.6x. Those metrics are far better than those for Ares Capital Corporation (ARCC) - which is perceived as having below sector average risk. The portfolio weighted average yield is 8.8% - and this important metric suggests well below average portfolio risk. With PFLT's debt/NAV at 24.62%, its leverage indicates much lower than average risk. The PNNT portfolio is 86.8% in secured debt - which indicates below average risk. PFLT has no loans at cost on non-accrual - another very low risk indicator. With investments in 63 portfolio companies, the PFLT portfolio rates a little below average on granularity or diversification. PFLT does not have publicly traded debt. PNNT's cost on its credit facility is LIBOR plus 2.00. That is below sector average - suggesting below sector average risk. The full menu of risk metrics consistently indicates that PFLT is low risk. PFLT should sell at a "yield plus CAGR" valuation that is noticeably lower than sector average.
But PFLT needs to create a second source of debt capital - or stay a low leveraged BDC - for me to assess it as being low risk. In the long run, having only a credit facility as a source of debt capital is dangerous. Credit facility covenants caused several higher leveraged BDCs to cut dividends - and in some cases sell of assets - at the depth of the credit crisis.
Before moving on the PFLT's valuation assessment, we should look at the BDC sector's current 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 1.72% and sector average yield (on Q1 dividends) at 8.95% - the spread is 723 bps.|
|The cap weighted ETF BDCS is up 4.10% year to date - with dividends its total return is 7.82%.|
|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 5.69%.|
BDC Earnings Growth & P/E Ratios 05-13
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|
My valuation assessment of PFLT
With a yield of 7.34% and a CAGR of 1.50%, the yield plus CAGR is only 8.84%. But a very low portfolio risk assessment justifies that low yield plus CAGR number. I am happy owning some REITs with similar yield plus CAGRs. But I believe those REITs warrant even lower risk assessments. Every time I think about adding to my low weighting in BDCs, I think about adding some relatively safe PFLT. And every time I worry about BDC portfolio risk, I think about adding some PFLT. But I strongly want to buy equities with yield plus CAGRs that are over 11%. PFLT falls short on that score.
On the other hand, I have a less than 2% weighting in a junk bond fund with a sub 6% yield and probably a negative dividend CAGR. It is a little crazy to dislike PFLT "as an equity" when PFLT could - with some imagination - be thought of as a substitute junk bond fund that I would love.
I have often criticized MLP (Master Limited Partnership) investors for owning low distribution CAGR MLP as "bond substitutes". Bonds are bonds - and equities are equities. The risk level is different. And the employment of "substitute thinking" results in giving one a license to buy poor yield plus CAGR investments. It is a license to under-perform. But old timers are conditioned to think that you get yield from bonds and growth from equities. The current environment has that world turned upside down. The desire of retirees to generate yield from their portfolios has them doing atypical things.
PFLT is an equity. I will refuse to think of it as a junk bond substitute. But if the purchase of higher yielding PFLT allowed you to buy a low yielding consumer staple stock with great credit metrics and decades of stable dividend growth, then go for it. To maintain my portfolio yield when adding consumer staple stocks to my portfolio, I have added BDCs in the same time period. This "in combination with" thinking may prove to be as erroneous as "bond substitute" thinking. But I need to generate a portfolio that pays my current bills. And these two potential errors should end with different results. If you buy PFLT as a bond substitute - your purchase decision is over. But if you buy PFLT in combination with a more secure and high dividend growth stock, you have lowered your portfolio risk and raised your portfolio dividend CAGR.
Now for a harder real world question using real world examples. Should you buy lower risk PFLT at a 7.34% yield in combination with the relatively lower growth and higher yielding Procter & Gamble (PG) - or 10.00% yielding PNNT in combination with higher growth but lower yielding Smuckers (SJM)? That depends on one's risk tolerances. And that depends on asset location decisions.
Behavioral finance tells us that almost every investor feels the pain of losses to a greater degree than the pleasure of an equal amount of gains. As a long-time investor who has consistently been heavy weighted in equity investments, I have some inoculation to that ailment or investing impediment. But with changes in my Roth IRA, the pain of any loss intensifies. The fact that it is economically logical to have this perception only makes the pain worse. IRAs and Roth IRAs are the logical asset location decision for any BDC purchase because BDCs do not pay qualified dividends. If I am making an investment in my Roth, then I want the relatively safe PFLT for my "in combination with" partner. If I am investing in a regular IRA, then I want PNNT for my "in combination with" partner. I fully acknowledge that such a judgment is as much emotional as it is logical. It is an decision that fits my temperament. I illogically own PNNT in my regular account - and I wish I could take that decision back. But I also own mostly lower risk and high dividend or distribution CAGR equities. So I correctly own PNNT - just in the wrong location.
Why would I end a perfectly good article on PFLT with such a wacky final few paragraphs? Because every investment decision that we make is an "in combination with" investment. Every investment decision is a tax decision, an asset location decision, a portfolio risk decision, and a portfolio growth decision. You have to balance those mostly conflicting needs to end up with a portfolio that fits you. And that ain't easy.