11.5% Yielder Selling At 21% Discount; Opportunity With Growth For This BDC
- AINV is a BDC which is trading at a yield of 11.5%. It is also trading at 21% discount to NAV.
- AINV is managed by a top-notch organization and has access to numerous attractive deals.
- AINV is in the process of a transition to a core strategy of senior secured loans at floating rates to solid clients.
- This BDC Company provides hedge against rising interest rates.
- AINV is a Strong Buy at the current price with a 15% upside potential.
This research report was jointly produced with High Dividend Opportunities co-author Philip Mause & Seeking Alpha Author Long Player.
Apollo Investment Corporation (AINV) traded recently at $5.24 and pays a dividend of 60 cents per year for a yield of 11.5%. AINV's latest financials indicate a net asset value ("NAV") of $6.60 a share, resulting in a discount of 21% at its current price per share.
The Business & Re-positioning of the Portfolio - AINV is a "business development company" (or BDC) that is in the business of lending to small and medium businesses which are often referred to as the "middle market." Management has committed itself to transitioning in the direction of its core business and migrating the asset mix in that direction. The core strategy is to acquire senior secured loans with interest at floating rates from credit-worthy borrowers in the middle market space. AINV also intends to reduce exposure to the energy area. AINV has been aggressively and successfully implementing this strategy:
- In the past year, the percentage of core assets in the portfolio increased from 66% to 74%.
- In addition, the percentage of floating rate loans to total loans increased from 84% to 92%.
- Secured debt now constitutes 81% of the total asset portfolio.
AINV is managed by Apollo Global Management (APO). We have written about APO and its success as an asset manager. AINV has access to the deals generated by this management and a high percentage of its loans are joint investments. The relationship with Apollo Global Management ensures that AINV will have access to a large number of potential deals and have the expertise available to make intelligent selections.
Recent Earnings Report - AINV recently reported its Q4 2017 earnings, and had a relatively good quarter.
- Net investment income of 16 cents a share, resulting in a dividend coverage of 104%.
- The Investment Portfolio Yield increased to 10.5% from 10.3% the previous quarter.
The fly in the ointment was a decline in NAV per share from $6.72 to $6.60 (or by 1.8%). But this is not worrying as AINV's management explained that this decrease was almost entirely due to three non-recurring events.
- First of all, AINV refinanced its debt associated with baby bonds; this financing will save interest expense in the long term but entailed an accounting charge of 3 cents per share.
- Secondly, AINV lost money on energy hedges that it employs in connection with some of its energy holdings: this loss was also 3 cents a share.
- Finally, AINV reported an unrealized loss of 4 cents a share associated with an asset which now has been repaid (after the close of the most recent quarter).
None of these events are expected to be recurring, and this removes concerns that this is a worrying long-term downtrend.
Low Leverage Provides Opportunities - AINV is maintaining a low leverage level of 0.61 times - well below the statutory limit of 1 time. This provides AINV with plenty of dry powder to address new opportunities while staying within the leverage limits for BDCs.
Hedge Against Rising Interest Rates - As stated above AINV has now 92% of its investment portfolio based on floating rates.
AINV has no substantial debt maturing before 2021 and 84% of its funding sources are based on fixed rates (consisting of equity and fixed rate debt).
The combination of its floating rate assets and fixed rates borrowings means that AINV will see its income increase as interest rates rise. AINV projects roughly an increase in income of $7 million per year for every 100 basis point increase in interest, or equivalent to roughly 6% increase in "Net Investment Income" each year.
Transitional Issues & Risks - AINV is transitioning out of various assets which are not consistent with its core strategy. We have reviewed AINV's latest quarterly report (10-Q) and have identified the specific investments at issue which fall into 4 categories:
- Common and preferred equity: AINV has exposure to common and preferred equity in the amount of $229 million. This includes a $41 million position in Merx which has been paying generous dividends to AINV.
- Pay-in-kind loans (or PIKs): AINV had PIK loans in the amount of $231.5 million. In making this calculation, we are including only loans which pay interest solely "in kind" (by the issuance of more debt). AINV also has some loans which pay considerable cash interest with a PIK "kicker" - these loans are not included in the calculation. In the most recent quarter, AINV recorded $5.8 million of PIK income (less than 10% of the $64.7 million of total investment income). After the end of the most recent quarter (subsequent events in the 10Q), AINV exited a very large PIK position which will result in a reduction of the total PIK loan amount by some $106 million for a realized loss of roughly 4 cent per share. Thus, at present, PIK loan exposure is reduced to $125.5 million.
- Structured products: AINV also has some $96 million of structured products.
- Non-performing loans: AINV has a very low level of non-performing loans ($35.2 million or roughly 1.5% of the portfolio) and most of this is due to PIK loans made to Spotted Hawk, an energy company.
The total of these investments, which AINV is transitioning out of, is roughly $416 million out of a total asset base of $2.416 billion. On a per share basis with a weighted-average share count of 218.3 million, the non-core assets are roughly $1.91 per share.
AINV has been doing well in the transition but there is always a risk that the worst assets are the ones that get divested last because the others are easier to sell. Still, it is very unlikely that AINV will experience losses on a magnitude that is in the neighborhood of its current $1.36 a share discount to NAV.
It is clear that the biggest risk is the $416 million of non-core assets - and in some cases problematic assets - on the books. If these can be exited without massive losses, AINV will be free to go its way pursuing a very sound core strategy under a top-notch management. The announcement of the exit in one key position after the close of the most recent quarter should have been encouraging to investors but the market did not seem to react.
Valuation & Price Target - Making a very pessimistic estimate of 30% loss on the $416 million of non-core assets or a loss of $124.8 million (57 cents a share), we get NAV of $6.03 - well north of the current price per share. After the non-core assets are shed, AINV will be a well-managed, powerhouse lender with conservative assets. It would not be unreasonable to project a price slightly above NAV at that point.
Based on our analysis, it appears that AINV is undervalued and should be trading in the neighborhood of at least $6 a share, or roughly 15% higher from here.
In fact, Wells Fargo (WFC) just upgraded AINV on February 8, 2018, to Outperform with a price target of $6 a share, which is in line with our analysis.
Big Share Repurchase Program - AINV has a huge share-repurchase program whereby the company has repurchased 1.73 million shares at a weighted average price per share of $5.77 from January 1, 2018, through February 6, 2018, or roughly 1% of the market cap in just one month. Since the inception of the program and through February 6, 2018, AINV repurchased 20.2 million shares for a total cost of $119.0 million (or 10.3% of the market cap), which is significant. This leaves $31.0 million available for future purchases under the current Board authorization of $150 million. Buying shares at a huge discount to NAV is very positive to current shareholders as it results in an immediate boost to the "Net Asset Value" per share.
Conclusion - AINV is a BDC company that is transitioning well to a higher quality company. It is trading at a significant discount which is unlikely to last. Investors are getting here a generous yield of 11.5% with a good hedge against rising interest rates. AINV is a strong buy at the current price and provides investors with an upside potential of 15%.
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All images above are taken from Company's website.
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