Apollo Investment: BDC Dividend Coverage Part 15

Jun.20.14 | About: Apollo Investment (AINV)

Summary

This article uses my ‘optimal leverage’ analysis to assess dividend coverage for Apollo Investment.

I have recently upgraded my outlook for Apollo Investment due to its continued focus on higher quality investments and the waiving of certain management and incentive fees.

The BDC industry is experiencing yield compression, and 7 out of the 26 BDCs that I cover have recently cut dividends.

I will use this series to project which BDCs are more likely to increase or cut dividends in the future.

This is a series of articles that discusses dividend coverage for most of the 26 BDCs that I cover in an effort to uncover companies that have the potential to sustain or increase current dividends. I will also be using this information to update my latest "BDC Rankings: May 2014". For more details regarding this series and for the dividend coverage results for TICC Capital (NASDAQ:TICC), Triangle Capital (NYSE:TCAP), Fidus Investment (NASDAQ:FDUS), PennantPark Floating Rate Capital (NASDAQ:PFLT), Gladstone Capital (NASDAQ:GLAD), Golub Capital BDC (NASDAQ:GBDC), PennantPark Investment (NASDAQ:PNNT), Hercules Technology Growth Capital (NYSE:HTGC), FS Investment Corp (NYSE:FSIC), Ares Capital (NASDAQ:ARCC), TCP Capital (NASDAQ:TCPC), THL Credit (NASDAQ:TCRD), New Mountain Finance (NYSE:NMFC) and Medley Capital (NYSE:MCC), please see:

Over the last five quarters, Apollo Investment (NASDAQ:AINV) has been increasing the amount of first lien senior secured debt in its portfolio as discussed in my "AINV Articles" where I have upgraded it to a 'Buy' after it beating analyst EPS estimates over the last four quarters with adequate dividend coverage. However, as AINV increases the quality of its portfolio, the overall yield from its investments has declined from 11.9% to 11.1% as shown in the table below.

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AINV has historically had higher amounts of leverage and has been recently keeping its debt-to-equity ratio below 0.70 through periodic equity offerings.

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Dividend and other income have accounted for around 10% to 15% of total income and are mostly attributable to its structured products and equity investments. For this analysis, I have used an average from the last four quarters since there is always a certain amount of 'recurring non-recurring' income included. The base management fees are driven by the amount of gross assets at 2.00% a year paid quarterly but excluding idle cash which is investor friendly. The incentive fees are par for the industry at 20% of pre-incentive net investment income and gains. For the time period between April 2, 2012 and March 31, 2015, Apollo Investment Management (the Investment Adviser) has agreed to voluntarily waive the management and incentive fee on the incremental common shares issued on April 2, 2012 and May 20, 2013. I have not included the benefit from waived fees for this analysis but this is also very investor friendly and another reason I have upgraded the company.

For projection purposes, I use core net investment income ("NII") that excludes both income and incentive fees related to capital gains. The following table shows the most recent quarter financial results along with projections at various levels of leverage and a stable portfolio yield of 11.1% to determine the impacts on dividend coverage. Each of these scenarios assumes a full quarter of benefit from interest income but also a full quarter of interest expense, base management and income incentive fees.

These scenarios assume the highest level of efficiency and actual results could be lower because there will always be some turnover in the portfolio (that could drive higher fee income). This analysis implies that AINV has a sustainable dividend even with lower amounts of leverage.

Side by Side Comparison:

The goal of using a side by side comparison is to show an 'apples to apples' view of each BDC with a stable portfolio yield, current cost structure and capital expenses with a portfolio that uses the same amount of leverage to increase return on equity investments. I will be using the amount of equity as of March 31, 2014 (or most recent) along with a debt-to-equity ratio of 0.80 and the current portfolio yield to project income and expenses, tracking the following metrics:

  • Dividend coverage (using a debt-to-equity 0.80)
  • BDC expenses (as a % of available income)

'Available income' is total interest and fee income less interest expense from borrowings and is the amount of income that is available to pay management expenses and shareholder distributions. BDCs with lower expenses can pay higher amounts to shareholders without investing in riskier assets.

The following table compares the results for AINV to the other BDCs (so far in this series). As you can see AINV has one of the highest 'operating cost as a percentage of available income' but with average dividend coverage. This would imply that AINV has a stable dividend relative to other BDCs but not much room for growth. I still believe TCPC, HTGC and FSIC have a much higher potential for dividend increases than the average BDC. I will continue to add more companies in the following articles.

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For more details including some of the potential variances to this methodology for assessing dividend coverage please see "Part 1" of this series.

Disclosure: The author is long ARCC, MAIN, FSIC, HTGC, TCPC, NMFC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.