PennantPark Floating Rate Capital: Don't Count Your Chickens Before They Hatch
Summary
- Currently, PennantPark Floating Rate Capital is trading at $12.58, and for that reason, I believe PFLT is trading at its fair value.
- I also believe that PFLT's investment portfolio will decrease by $8 million in 2Q21, and I estimate that this could result in a NAVPS loss of $0.2060.
- US Bankruptcy filings are expected to increase in the second semester of 2021.
I have spent the past four months working on a complicated and time-consuming project. As you could imagine, writing an article during that period was definitely out of the question. But if I had been able to write articles during that period, I would have written two on PennantPark Floating Rate Capital (NYSE:PFLT). The first article would have been called "The Market Is Beginning To Understand PFLT's Risks" and the second would have been "Business As Usual For PFLT." As you soon will read, I no longer believe that PFLT has reached the "business as usual" milestone.
Graph 1 - PFLT Last Six Months
When I look at graph 1, it seems to me that there are three periods. One period where the market recovered quickly (where I believe risks were being properly calculated) and where PFLT's value crept towards its most recently published NAVPS. The last couple of weeks of April is where I believe the market became optimistic towards PFLT's future.
Non-Accrual Loans And Their Risks To Investors
Figure 1 - Heatmap
Source: Company's Financials
Figure 1 shows that non-controlled, non-affiliated investments have a large positive gap. A large positive gap means that the fair value of the investment is greater than its cost. For investors, this is good news because it increases the company's GAAP NAVPS. Non-controlled, affiliated investments have the largest negative gap, which brings me to question what is occurring here. Risk premiums have decreased over the past six months. When the company believes a loan has a high chance of becoming a non-performing loan, it increases the loan's risk premium, reducing its fair value.
Since PFLT's inception, it has only had 13 non-accrual loans out of 387 companies. According to the company, PFLT had nine non-accrual loans at the end of 1Q20. After 1Q20, four loans were classified as non-accrual loans. I analyzed the company's portfolio during the period, and I found that a company named Quick Weight Loss Centers, LLC was responsible for these non-accrual loans. Since these loans were already at a discount as of December 31st, 2019, it is logical to believe that Quick Weight Loss Centers was already in trouble before the pandemic.
While researching Quick Weight Loss Centers, I discovered another group of loans that had a fair value that was significantly lower than its costs. The issuer of these loans is Country Fresh Holding Company. In 1Q20, the common equity investment was the only instrument issued by Country Fresh that was discounted (fair value was 34.3% less than cost). Throughout the subsequent quarters of the 2020 fiscal year, the fair value of the loans was discounted too.
Now for the important part of this research. PFLT and its subsidiary PSSL have invested nearly $25 million in Country Fresh. The current fair value of these investments is nearly $8 million (68.4% discount to cost). In February of this year, I just discovered that Country Fresh Holding Company and its subsidiaries filed for chapter 11 bankruptcy.
PFLT will publish its 2Q21 financials in a few days. I believe we will see several more non-accrual loans in those financials. I also believe that PFLT's investment portfolio will decrease by $8 million, and I estimate that this could result in a NAVPS loss of $0.2060. The GAAP NAVPS in 1Q21 was $12.70, and with this loss, we can expect the 2Q21's NAVPS to be around $12.50.
Figure 2 - US Bankruptcy Filings - TTM (Chapter 7, 11, 13, & 15)
Source: American Bankruptcy Institute "ABI"
Before the pandemic, there was an average of 38,500 accumulative bankruptcy filings. Now the TTM average is down to almost 29,000. I believe that 38,500 is the natural rate of bankruptcy filings. I mean that during a good economic environment with low unemployment and good GDP growth, an average of 38,500 individuals and businesses will file for some type of bankruptcy throughout the fiscal year.
To better explain what I believe occurred in the shaded red area of Figure 2, I will use Country Fresh Holding Company as an example. In December of 2019, PFLT had already begun discounting its equity investment in Country Fresh, meaning it was already having financial trouble. The company received a PPP loan, but that loan only kicked the can down the road, as we have come to learn. I believe that this same scenario is occurring right now, and for that reason, I will continue to add a BDC-specific risk premium to my valuations of BDCs.
Conclusion
From 1Q20 to 1Q21, PFLT's GAAP NAVPS went from $12.95 to $12.70. During the same period, the company paid out $1.14 in dividends and had a Net Investment Income of $1.08. Ideally, we would have wanted PFLT's NII to be slightly more than dividend payouts, but even then, it would not have prevented the $0.25 decline in NAVPS as that was mainly caused by non-accrual loans.
Figure 3 - DDM For PFLT
Source: Seeking Alpha and analyst's estimates
Figure 3 demonstrates the three scenarios that I believe could occur in the next two years. I want to point out that I feel there is a 90% chance that PFLT will reduce its dividends next year. This scenario analysis doesn't consider the possibility of PFLT issuing more shares and using these funds to increase the size of the investment portfolio.
In conclusion, due to a shrinking investment portfolio caused by non-accrual loans and the increase in risks for PFLT, I estimate that PFLT's fair value is $12.50. Currently, it is trading at $12.58, and for that reason, I believe PFLT is trading at its fair value.
This article was written by
Analyst’s Disclosure: I am/we are long PFLT. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (37)
“We achieved another substantial increase in NAV during the quarter. Adjusted NAV increased 2.3% from $12.32 to $12.60 as our portfolio continue to improve. We have several portfolio companies in which our equity co-investments have materially appreciated in value as they are benefiting from the economic recovery. “
And only 2 loans on nonaccrual.
Still, it’s always good to stay vigilant.
GLTA
So at what premium to nav would be your sell price ?
