This article is a follow-up to "High-Yield BDC Pricing: Q1 2016" that discussed a very simplistic method of pricing for higher yield business development companies ("BDCs"). BDCs have rallied 10% to 30% since, and most of the companies that were considered "underpriced" in the previous article, rallied the most. This article will use the same approach.
Changes in NAV per Share
Many BDC investors believe that BDCs should be priced mostly based on net asset value ("NAV"). However, investors also need to take into account NAV per share growth (or decline) rates and many higher yield BDCs have a history of NAV per share declines and/or potentially overstated portfolio values. The following table shows the change in NAV per share over the last two years but many of the higher quality BDCs have been marking down assets to reflect general market pricing rather than credit related issues including Ares Capital (NASDAQ:ARCC) that mentioned the following on a recent call:
"As should be expected, we recognized some unrealized depreciation in the portfolio in the fourth quarter, the bulk of which resulted from negative mark-to-market yield-related valuation adjustments, rather than markdowns dictated by credit issues at underlying portfolio companies. At a high-level, we continue to see stability and growth at our underlying portfolio companies."
The value of these assets are constantly changing and could be seen as guesstimates. There are many variables that go into pricing assets for BDCs including mostly Level 3:
"Assets whose fair value cannot be determined by using observable measures, such as market prices or models. Level 3 assets are typically very illiquid, and fair values can only be calculated using estimates or risk-adjusted value ranges."
Many of the BDCs that have maintained their NAV per share during this period have lower yields such as Main Street Capital (NYSE:MAIN), Saratoga Investment (NYSE:SAR), Monroe Capital (NASDAQ:MRCC), Golub Capital BDC (NASDAQ:GBDC), TPG Specialty Lending (NYSE:TSLX), Fidus Investment (NASDAQ:FDUS), and TCP Capital (NASDAQ:TCPC).
Comparison of Higher Yield BDCs
The following table shows the current dividend yield and price-to-NAV multiples for the BDCs with higher dividend yields.
THL Credit (NASDAQ:TCRD), Prospect Capital (NASDAQ:PSEC), Stellus Capital Investment (NYSE:SCM) and TriplePoint Venture Growth (NYSE:TPVG) have the lowest yield compared to the others but they also have less declines in NAV per share as shown in the previous table. Not a coincidence.
BDCs have rallied 10% to 30% higher since the previous "High-Yield BDC Pricing: Q1 2016" article linked above as predicted in "Are BDCs At Another Buying Point?"
The following table uses the average price-to-NAV multiple of 0.75 (was 0.61 previously) and dividend yield of 15.5% (was 17.7% previously) from the previous table to imply pricing for each BDC.
For example: Using the average yield of 15.5%, Apollo Investment (NASDAQ:AINV) would be priced closer to $5.15 and using an average price-to-NAV of 0.75 it would be closer to $5.45. Both of these implied prices are relatively close to the current $5.26.
In the previous article, the results showed that BDCs such as KCAP Financial (NASDAQ:KCAP), PennantPark Investment (NASDAQ:PNNT), Full Circle Capital (FULL), Capitala Finance (NASDAQ:CPTA), and SCM were the best-priced higher yield BDCs and all of these have rallied between 22% to 31% since then. The article also implied that BDCs such as AINV, PSEC, TPVG and WhiteHorse Finance (NASDAQ:WHF) were not as undervalued as the others and these companies are only up 10% to 12% during the same period.
This oversimplified approach implies that Medley Capital (NYSE:MCC), TICC Capital (TICC), Fifth Street Finance (FSC) and KCAP are the best-priced higher yield BDCs. However, there is good change that investors are expecting dividend cuts for these companies in the coming quarters. Again, this is a very simplistic method of pricing and personally I use a system based on relative risk, dividend potential and qualitative measures of management applied to expected returns for each BDC. If you are interested in more information on BDCs including individual dividend coverage potential, risk profiles, valuations, and rankings, please see my "BDC Research Page" and for my free monthly newsletter, please visit "BDC Buzz.com".
Personal note: I have updated my positions to reflect changes in my holdings, but please keep in mind that some of the positions are very small and mostly for research purposes.
Disclosure: I am/we are long ABDC, AINV, ARCC, BKCC, FDUS, FSC, FSFR, FSIC, GAIN, GARS, GBDC, GLAD, GSBD, HTGC, MAIN, MCC, MRCC, NMFC, PFLT, PNNT, PSEC, TCAP, TCPC, TICC, TPVG, TSLX.
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.