BlackRock Capital Investment Corporation - Don't Be Tempted By This Low-Quality, High-Yield BDC

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About: BlackRock Capital Investment Corporation (BKCC), Includes: MAIN
by: John Windelborn
Summary

BKCC's 11.6% yield has been covered in only 1 of the last 4 quarters.

Average 3 year dividend growth of negative 4.7%.

Portfolio is only 27.8% senior secured 1st lien debt, which is far beneath peers and represents a much higher risk set of holdings.

Past 5 year total return performance is nearly 6 times worse than the market.

BlackRock Capital Investment Corporation (BKCC) is the perfect example of the confluence of chasing yield and investing based on name recognition. Potential investors might be swayed by the fact that the BDC is owned/managed by BlackRock (BLK), which is one of the largest players in the ETF and asset management business. That doesn’t mean that this BDC is successful. In fact, this BDC has been a horrible investment for anybody to hold for virtually any period in time since its inception. Where applicable, I will try to include comparative values from the far superior members in the BDC space, Main Street Capital (MAIN) and Gladstone Investment (GAIN). Either of those two companies would be far preferable to place one’s hard earned cash.

Image from finviz.com

Unless you swing-traded BKCC last month in-step with the broad-market recovery from the December sell-off, you’re most likely looking at a break-even best scenario. Long term shareholders have felt the pain more than short term shareholders, which is never a good sign for a stock’s viability.

Image from Seeking Alpha

The 5-year total return of BKCC (this includes dividends) is a paltry 12.97% compared to the S&P 500’s total return of 72.14%. MAIN sports a very competitive 70.02% 5-year return and GAIN is the leader at 114.86%.

Image from Seeking Alpha

Particularly disheartening is the gradual but downward drift in dividend payout per share. The company has been forced to reduce the dividend due to a declining net interest income. BKCC has regularly posted double-digit YoY NII declines, while both GAIN and especially MAIN have managed double-digit NII growth for many of the prior quarters. This growth has resulted in a 3 year dividend growth rate of 4.43% per year for GAIN and 2.77% for MAIN (both pay a special dividend and was not factored in). BKCC is a negative 4.7% average decline.

Past performance is one thing, but shouldn’t we be more interested in the current investment thesis? What’s the future look like for BKCC?

Image from BKCC Q3 earnings slides

We have a dwindling asset base producing declining income that had a small uptick in the most recently reported quarter. The distribution coverage has only been at or above 100% once in the last four quarters. This is a huge red flag warning sign to investors. A bad quarter that doesn’t cover the dividend isn’t the end of the world, but consistently under-earning the payout is a recipe for disaster. A net asset value per share of $7.66 means that the price to book ratio is currently only 0.81. However, this size of a discount is fairly common in the BDC space (GAIN has a 0.89), and you don’t get a premium of 1.51x book value like MAIN without a long track record of both growth and safety.

On the plus side, net leverage has come down since two quarters ago. However, I’m left wondering why they chose to deploy capital in this fashion since they report that their weighted average yield of borrowings is 4.7% and their average yield of investments is 11.4%. Yes, 40% of their debt is floating rate, but with rate increases looking to be stagnant in the future and no debt maturities until 2022 there really wasn’t a pressing need to pay down the debt.

Not to beat a dead horse, but I’m concerned about the company’s investments moving forward:

Image from BKCC Q3 earnings slides

Their portfolio is shrinking in size of different companies, which is leading to less diversity of clients. In the tenant or loan business you typically strive for increased diversity so that financial problems with bankruptcy are minimal. In addition, there has been a shift of debt issued to clients in the past few quarters (and increasing as of late) to unsecured debt and common equity. These are the riskier of the lending classes as compared to 1st or 2nd lien debt, because it means that if the company goes bankrupt BKCC will essentially get nothing. I view this as a desperate attempt to juice more net interest income as these higher risk loans should come with increased potential yield. BKCC’s total loan portfolio is only 27.8% senior secured 1st lien debt. GAIN’s portfolio is comprised of 47.5% senior secured 1st lien debt, and MAIN’s LMM portfolio is 98.5%.

Other Option

For those income investors that are starving for yield, there is another option that I believe would be far better than buying BKCC. Consider executing a buy-write for 100 shares of MAIN. Buying 100 shares of main would cost you $3735 before commissions, and then sell a covered call for June 21st 2019 at the $40 strike price. The premium that you receive upfront is going to be about $45 before commissions, which is an immediate 1.2% return.

Image from yahoo finance option chain

Since MAIN pays monthly, you will receive 4 monthly dividends of $0.195 and 1 special dividend of $0.275 (assuming MAIN continues to pay these out and assuming no monthly dividend growth). This dividend income of $1.055 per share would represent an additional 2.8% yield on your original investment. Now say the share price exceeds $40 on June 21st and your shares are sold. You get $4000 in proceeds.

(4000 + 45 + 105) / (3735) = 11.1% return, or ~22.2% annualized return.

This far exceeds the non-covered 11.6% annual yield of BKCC and represents a much larger margin of safety. Even if shares don’t hit $40 and you keep your shares, you’re holding a blue-chip stock that you can sell another covered call on and receive even more dividends.

Summary

I’m not trying to shame current investors with this article, I’m merely suggesting that new potential investors should examine BKCC very carefully if they’re thinking of starting a new position. With declining assets, declining net interest income, a non-covered dividend that has a history of being cut, a higher risk and less diverse loan portfolio and questionable moves by management to deleverage, I’m not touching BlackRock Capital Investment Corporation with a 10-foot pole. I think it’s safe to say that BKCC represents a “sucker yield” as the big dividend doesn’t make up for the share price declines, and total return lags both BDC peers and the S&P 500 (SPY). As I’ve shown with side-by-side comparisons, GAIN and MAIN are far superior choices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.