FS Investment Corporation (NYSE:FSIC) - a.k.a. "Franklin Square" - is out performing the BDC (or Business Development Company) sector average year to date. It is one of few BDCs selling above its NAV or Net Asset Value price. So things must be going well. Not exactly.
Moody's, in an update of 5-17-16, warned that some BDCs appear to be understating energy loan losses - and that future markdowns would results in them breaching their debt asset coverage ratio requirements - a condition that endangers their dividend payouts. FSIC was one of two BDCs Moody's called "at greater risk of ACR (Assessing Credit Risk) breach". That sounds like one big headwind to future price appreciation.
At the same time, the consensus earnings projections are noticeably declining from $1.00/share at the start of the year to the current $0.83. Here is the data from Yahoo Finance:
|EPS Trends||Current Qtr. |
|Next Qtr. |
|Current Year |
|Next Year |
|7 Days Ago||0.23||0.23||0.81||0.91|
|30 Days Ago||0.23||0.23||0.92||0.93|
|60 Days Ago||0.23||0.23||0.92||0.95|
|90 Days Ago||0.26||0.25||1.00||0.98|
There is an apparent disconnect between the news and the pricing. This article attempts to clean up that muddy picture by looking at the performance and valuation metrics. Unfortunately, a clean picture results in my providing a "two handed economist" kind of advice to current and potential share holders. But at the same time, we will visit a boat lode of data and talk about some valuation concepts that could result in you becoming a better investor.
I want to start with the current price performance and key valuation metrics that I will eventually use in my valuation assessment:
Yield in the spreadsheet below is based on the Q2-16 'regular' 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. Due to calendar and fiscal years failing to overlap, I also include a dividend to the sum of the last four quarters of NII - in the Div/NIIltm column. After the Price/NAV ratio, the next column displays the percent change in price YTD. The next display price change plus YTD dividends accrued on the payment date - not the earned date. For the last four columns - the first measures the percentage change in the 2016 EPS projection since the beginning of the year; the second measures the change in the price target since the beginning of the year; the third measures the change in the Q2-16 dividend from the Q2-15 dividend; and the last measures the change in NAV between Q1-16 and Q1-15. Special dividends are not included in this data. ARCC, FDUS, MAIN and TCPC have paid special dividends on a near regular schedule.
|Share Price||Div/||Div/||Div/||Div/||Q1-16||Price||YTD Percent Change||LTM %||LTM %|
|Alcentra Capital Corporation||(NASDAQ:ABDC)||11.60||12.00||11.33||100.0||94.4||92.3||9.4||14.41||0.83||3.45||9.31||-4.90||-6.03||0.00||-3.29|
|American Capital Senior Floating||(NASDAQ:ACSF)||9.83||9.99||11.61||103.6||95.9||92.7||9.8||11.72||0.85||1.63||7.53||-8.94||-10.08||0.00||-19.23|
|Apollo Investment Corporation||(NASDAQ:AINV)||5.22||5.35||14.95||95.2||96.4||96.6||10.6||7.28||0.73||2.49||10.15||0.00||-11.13||0.00||-11.00|
|Ares Capital Corporation||(NASDAQ:ARCC)||14.25||15.02||10.12||98.1||94.4||94.8||9.2||16.50||0.91||5.40||8.07||-2.52||-6.76||0.00||-1.26|
|BlackRock Capital Investment||(NASDAQ:BKCC)||9.40||7.36||11.41||83.2||86.6||87.8||8.3||9.64||0.76||-21.70||-19.47||0.00||-10.99||0.00||-8.88|
|CM Finance Inc||(NASDAQ:CMFN)||10.02||8.13||17.07||95.1||106.8||87.4||11.4||11.96||0.68||-18.86||-11.94||15.87||-23.33||0.00||-17.06|
|Capitala Finance Corp.||(NASDAQ:CPTA)||12.08||13.24||10.60||77.1||75.1||79.9||8.2||16.29||0.81||9.60||12.51||-5.21||-11.93||-25.32||-11.23|
|Fidus Investment Corporation||(NASDAQ:FDUS)||13.69||15.03||10.38||94.0||92.9||92.8||10.3||15.25||0.99||9.79||12.64||-0.60||-2.03||2.63||0.39|
|Fifth Street Finance Corp.||(NASDAQ:FSC)||6.38||5.01||14.37||101.4||93.5||101.9||8.6||8.33||0.60||-21.47||-17.81||-7.79||-17.46||0.00||-9.26|
|Fifth Street Senior Floating Rate||(NASDAQ:FSFR)||8.57||7.39||12.18||96.8||94.7||99.5||7.9||11.18||0.66||-13.77||-8.52||-6.06||-14.80||-25.00||-10.27|
|Franklin Square Investment Corp||8.99||8.91||10.01||101.4||98.0||82.1||9.8||8.82||1.01||-0.89||4.07||-12.00||-12.06||0.00||-10.91|
|Full Circle Capital Corporation||(NASDAQ:FULL)||2.47||2.60||16.15||123.5||85.7||92.4||11.2||3.61||0.72||5.26||10.79||-19.05||2.18||0.00||-18.51|
|Gladstone Investment Corporation||(NASDAQ:GAIN)||7.67||6.79||11.05||125.0||102.7||109.5||8.7||9.22||0.74||-11.47||-8.21||-16.67||-3.03||4.17||0.44|
|Garrison Capital Inc.||(NASDAQ:GARS)||12.17||9.87||14.18||100.7||95.9||82.9||10.0||13.50||0.73||-18.90||-16.02||-11.46||-14.86||0.00||-12.39|
|Golub Capital BDC, Inc.||(NASDAQ:GBDC)||16.63||16.84||7.60||99.2||97.7||104.6||8.1||15.85||1.06||1.26||3.19||-3.01||-0.56||0.00||1.54|
|Gladstone Capital Corporation||(NASDAQ:GLAD)||7.31||7.04||11.93||98.8||100.0||92.2||10.0||7.92||0.89||-3.69||-0.82||1.19||-16.38||0.00||-17.07|
|Goldman Sachs BDC||(NYSE:GSBD)||19.00||19.88||9.05||85.7||87.0||81.6||9.5||18.67||1.06||4.63||9.37||1.94||-6.34||0.00||-3.81|
|Harvest Capital Credit||(NASDAQ:HCAP)||11.73||12.84||10.51||102.3||95.1||83.1||9.5||13.90||0.92||9.46||13.20||-7.04||-8.47||0.00||-2.80|
|Share Price||Div/||Div/||Div/||Div/||Q1-16||Price||YTD Percent Change||LTM||LTM|
|Horizon Technology Finance Corp||(NASDAQ:HRZN)||11.73||11.72||11.77||97.9||97.2||103.7||10.0||13.62||0.86||-0.09||3.74||-0.70||-1.36||0.00||-4.02|
|Main Street Capital Corporation||(NYSE:MAIN)||29.08||31.45||6.87||99.5||95.6||97.9||10.2||21.18||1.48||8.15||10.63||-7.66||-3.72||2.86||-3.16|
|Medley Capital Corporation||(NYSE:MCC)||7.52||6.60||18.18||142.9||110.1||104.8||12.0||9.80||0.67||-12.23||-8.24||-31.71||-24.43||0.00||-16.10|
|Monroe Capital Corporation||(NASDAQ:MRCC)||13.09||13.61||10.29||84.3||88.6||86.1||9.9||14.45||0.94||3.97||6.65||3.11||0.12||0.00||2.41|
|New Mountain Finance Corporation||(NYSE:NMFC)||13.02||12.27||11.08||102.3||97.1||106.6||10.4||12.87||0.95||-5.76||-3.15||-6.99||-10.00||0.00||-7.34|
|OFS Capital Corporation||(NASDAQ:OFS)||11.48||13.37||10.17||99.3||85.5||92.0||9.2||14.65||0.91||16.46||19.43||-7.43||9.85||0.00||2.88|
|Oak Hill Advisors||(NASDAQ:OHAI)||3.80||2.36||20.34||129.7||111.6||100.7||8.7||4.85||0.49||-37.89||-31.58||-13.95||0.00||0.00||-33.29|
|Prospect Capital Corporation||(NASDAQ:PSEC)||6.98||7.43||13.46||97.1||101.0||96.6||10.2||9.61||0.77||6.45||11.10||0.98||-18.05||0.00||-6.70|
|PennantPark Floating Rate Capital||(NASDAQ:PFLT)||11.25||11.74||9.71||112.9||97.4||125.7||8.3||13.54||0.87||4.36||7.65||0.00||-5.01||0.00||-5.31|
|PennantPark Investment Corp||(NASDAQ:PNNT)||6.18||6.17||18.15||107.7||112.0||104.8||12.4||8.83||0.70||-0.16||4.37||2.97||-16.17||0.00||-13.85|
|Saratoga Investment Corp.||(NYSE:SAR)||15.42||16.38||10.01||86.3||86.8||85.6||7.3||22.06||0.74||6.23||8.88||-2.56||-7.50||51.85||-2.82|
|Stellus Capital Investment||(NYSE:SCM)||9.64||9.96||13.65||106.3||100.0||109.9||10.3||13.06||0.76||3.32||10.37||-3.76||-6.35||0.00||-6.91|
|Solar Capital Ltd.||(NASDAQ:SLRC)||16.43||18.14||8.82||95.8||89.9||101.5||7.7||21.08||0.86||10.41||12.84||-4.02||-4.72||0.00||-3.79|
|Solar Senior Capital Ltd.||(NASDAQ:SUNS)||14.90||15.55||9.07||95.3||99.3||104.5||8.6||16.70||0.93||4.36||6.73||4.96||-5.03||0.00||-5.38|
|Medallion Financial Corp.||(NASDAQ:MFIN)||7.04||7.34||13.62||89.3||86.2||60.2||8.8||11.46||0.64||4.26||11.36||-12.50||0.00||0.00||2.69|
|Triangle Capital Corp||(NYSE:TCAP)||19.11||17.79||10.12||97.8||85.7||94.3||11.8||15.02||1.18||-6.91||-4.55||-19.65||-7.08||-16.67||-3.96|
|TCP Capital Corp.||(NASDAQ:TCPC)||13.93||14.21||10.13||92.9||90.6||87.9||9.7||14.66||0.97||2.01||4.59||-5.49||-5.51||0.00||-2.46|
|THL Credit, Inc.||(NASDAQ:TCRD)||11.70||10.12||13.44||95.8||97.1||92.8||10.8||12.24||0.83||-13.50||-10.60||1.43||-10.96||0.00||-7.27|
|TICC Capital Corp.||(NASDAQ:TICC)||6.08||5.13||22.61||173.1||246.8||200.1||18.1||5.89||0.87||-15.63||-10.86||-5.63||-37.50||0.00||-32.45|
|TriplePoint Venture Growth||(NYSE:TPVG)||11.96||10.39||13.86||100.0||86.7||100.1||10.1||13.40||0.78||-13.13||-7.11||-14.29||-6.69||0.00||-7.46|
|TPG Specialty Lending||(NYSE:TSLX)||16.22||16.06||9.71||92.9||92.3||86.9||10.3||15.11||1.06||-0.99||3.82||0.00||-3.66||0.00||-3.14|
|With the 10 Treasury at 1.82% and sector average yield on Q1 dividends at 12.44% - the spread is 1062 bps.|
|The cap weighted ETF BDCS has a price change of -3.85% year to date - with dividends its total return is 0.64%.|
|The SPY or S&P 500 EFT is 0.16% year to date. - and with unreinvested dividends is 0.68% year to date.|
BDC Earnings Growth & P/E Ratios 05-19
Fiscal and calendar years are not in sync. BDCs than began fiscal 2016 on or before calendar Q4-15 include AINV, FULL, FSC, 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. All EPS projections are from Yahoo Finance - with the exceptions of ASBC and FSIC - where projections are not NIIs.
|Earnings / Share||Earn. Growth||P/E Ratios||Current Fiscal Year|
|Earnings / Share||Earn. Growth||P/E Ratios||Current Fiscal Year|
FSIC sells at a 10.01% yield compared to a sector average yield of 12.44%. FSIC sells at a 101% Price/NAV ratio while the sector average ratio is 85%. That is richly valued for a BDC with a LTM NAV fall of 10.91% compared to a sector average fall of 8.40%.
FSIC sell at a 10.13 P/E or what is really a "Price/Net Investment Income" ratio compared to the sector average of 8.52. That is richly valued for a BDC that is projected to have slightly less that sector average earnings growth in 2016 and 2017.
I will move on to the current earnings information.
FSIC Reports NII of $0.2056/share compared to a Dividend of $0.22275
What They Earned Franklin Square Investment Corporation announced Q1-16 total operating income $103.063 million ($0.4244/share) and net investment income of $49.938 ($0.2056/share). The Net Increase in Net Assets Resulting from Operations was -$12.097 million or -$0.0498/share due to $62.035 million in realized and unrealized losses in the portfolio. NAV was $8.82 compared to $9.10 last quarter. FSIC IPOed on 4-16-14 at $10.00. At 3-31-16, energy investments of $0.383 million were 10% of the portfolio at fair value. The percentage of investments on non-accrual was 0.3%.
|Realized & Unrealized Gains||-62.035||-134.619||-69.045||-41.818||18.777||-78.244||-4.504||11.338||24.183||24.388||-8.155||-27.116||31.747|
|Realized & Unrealized Gains/share||-0.2554||-0.5544||-0.2850||-0.1730||0.0779||-0.3254||-0.0188||0.0444||0.0937||0.0944||-0.0318||-0.1067||0.1256|
|Total investment income||103.063||114.763||103.668||147.731||108.939||113.385||115.917||120.721||114.796||116.866||123.307|
|Net expenses and excise taxes||53.125||58.612||39.902||54.207||56.986||45.330||55.814||62.748||58.919||64.446||55.535|
|Net investment income||49.938||56.151||63.766||93.524||51.649||68.055||60.103||57.973||55.877||52.420||67.772|
|Investments @ fair value||3.867||4.029||4.100||4.007||4.162||4.183||4.138||4.227||4.078||4.137||4.201|
|Wt Av Share Count||242.847||242.800||242.228||241.653||241.084||240.480||239.549||255.301||260.186||258.263||256.108|
|NII/share my calculation||$0.2056||$0.2313||$0.2632||$0.3870||$0.2142||$0.2830||$0.2509||$0.2270||$0.2228||$0.2030||$0.2646|
|Reported Adjusted NII/share||$0.21||$0.24||$0.21||$0.35||$0.23||$0.24||$0.25||$0.26||$0.23||$0.24||$0.25|
|Weighted Average Yield||9.6%||9.8%||9.9%||9.9%||10.0%||10.0%||10.3%||10.3%||10.3%||10.2%||10.4%|
|Portfolio Company Leverage||5.0x||4.9x||4.7x||4.8x||4.8x||4.6x||4.4x||4.1x||4.0x|
|Q4-15 had $6.056 million in excise taxes, which significantly raised expenses that quarter. Q4-14 had $5.400 million.|
|Q4-14 had a $15.662 million reversal in capital gains incentive fees, which significantly lowered expenses that quarter|
|Q2-15 had a $8.355 million reversal in capital gains incentive fees, lowering expenses, due to a $41.818 million write-down in investments|
|Q3-15 had a $13.811 million reversal in capital gains incentive fees, lowering expenses, due to a $69.045 million write-down in investments|
|Adjusted NII excludes the accrual for the capital gains incentive fee, excise taxes; and certain non-recurring operating expenses|
What They Own First Lien Senior Secured Loans were 54% of the FSIC portfolio; Second Lien Senior Secured Loans were 15%; Senior Secured Bonds were 5%; Subordinated debt was 12%; Collateralized Securities were 2%; and 'equity and other' as 12% as of 3-31-16. As of March 31, 2016, approximately 0.3% of investments were on non-accrual based on fair value. FSIC had investments in 111 portfolio companies.
I will now take the data from the above spreadsheet to do a quick and crude Net Investment Income run rate calculation below. Remember that all BDCs have anemic growth expectations. Thus a run rate projection can also serve as a de facto forward projection.
|Metric||Fee Income||---------- Interest Income ----------||Totals|
|Formula||average for last 4 quarters||portfolio times yield / 4||Sum of components|
|Numbers||8.267*||3,867 million times .096 / 4||108.967|
|Fee income is both volatile and a key TII component - causing the NII/TII ratio to also be volatile|
|Net Investment Income Calculation|
|Formula||average for last year||TII times NII/TII||NII/ share count|
|Numbers||55%||.51** times 108.967||55.573 / 242.847||$0.2288/share|
|The consensus analyst TII projection is (425.980 / 4) 106.495 and NII projection is ($0.83 / 4) $0.2075/share/quarter|
I put an asterisk by the "average for the last four quarters" Fee Income line because one of those quarter had an atypically large number. Q2-15 had $25.721 million in fee income. I substituted the second largest fee income quarter for Q2-15 number in the calculation of the average.
I put two asterisks by the NII/TII ratio number of 51%. Two of the last four quarters had atypically high NII/TII ratios. The Q2-15 ratio was high due to high fee income. The Q3-15 ratio was high due to atypically low expenses.
Let's now compare those numbers to the current analyst projections from Yahoo Finance:
|Earnings Est||Current Qtr. |
|Next Qtr. |
|Current Year |
|Next Year |
|No. of Analysts||6.00||6.00||4.00||6.00|
|Revenue Est||Current Qtr. |
|Next Qtr. |
|Current Year |
|Next Year |
|No. of Analysts||4||4||5||6|
My annualized TII projection of (4 x 108.967) $435.868 is a tad higher than the highest analyst projection. My annualized NII projection of (4 x .2288) $0.9152 is right in line with the high analyst projection. Even with my downward adjustments, I still have bullish projections for fee income and the NII/TII ratio. Thus I am not surprised that my run rate numbers results in a bullish projection. But what is up with the $0.63 "low projection" number?
My theory is that one of the analysts is providing a "Net Increase in Net Assets Resulting from Operations" (which is GAAP EPS) number for Q1 in their "Net Investment Income" projection for the year. Q1-16 GAAP EPS was a loss of 5 cents. Replace that 5 cent loss with a 20 cent NII and one arrives at (63 + 5 + 20) an $0.88 projection.
Let go in a different direction in expressing the same idea. An initial projection of 22 cents per quarter is an $0.88 annual projection. Substitute one of those 22 cent quarters with a negative $0.05 cent quarter and one arrives at (-5 + 22+ 22 +22) a $0.61 projection for 2016. The negative $0.05 comes from or matches the actual Q1-16 "Net Increase in Net Assets Resulting from Operations".
And that is my first and only bit of good news for FSIC share holders in this article. It is my logic backed theory that the decline in the 2016 earnings projection is due to "earnings metric inconsistency" done by one analyst. It is noise without substance. And this is my justification for using a number for the 2016 FSIC earnings projection that is much higher than the projection one finds at Yahoo Finance.
My Valuation Assessment.
FSIC sells at a premium to the sector based on yield, Price/NAV and Price/NII or (non-GAAP) EPS. At the same time, FSIC has too many attributes that tell me it should not sell at a premium. The weighting in energy loans is a problem. Most BDCs with high energy exposure sell at discounts (see AINV and PNNT). The falling NAV is a big problem. NAV falling BDCs strongly tend to sell at discounts. The dividend coverage is non-existent in 2016 and tiny in 2017. Low coverage strongly correlates to lower valuations. FSIC has a business model of generating a high enough percentage of income from portfolio churn (like the prepayment fees that go into fee income) that it has an annual earnings amount that is hard to forecast. "Hard to forecast" companies strongly tend to sell at valuation discounts.
Concerning 2016 price performance, BDCs with falling earnings projections strongly tend to under perform. Even with my upward adjustment to the NII projection, the FSIC 2016 projection is falling. BDCs with price target changes that are lower than sector average also tend to under perform. FSIC has price target that is falling faster or larger than sector average.
Those are a heck of a lot of disconnects. I would strongly suggest that FSIC is not included in your buy list. At the same time, there is lots of inertia in BDC valuations. Under valued BDCs tend to stay under valued. Over valued BDCs tend to stay over valued. I am not projecting that an imminent price fall is coming to FSIC. Add to that, FSIC does have some positive attributes. You could choose worse.
Disclosure: I am/we are long AINV, ARCC, FDUS, MRCC, PFLT, PNNT.
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.