BKCC - BlackRock Capital Investment: A Misunderstood Deep Value Play

2023-10-30 10:45:47 ET

Summary

• BlackRock Capital Investment Corp. will benefit from stabilizing higher interest rates.
• BKCC's credit is largely not fixed rate, allowing it to increase income while expenses on debt remain the same.
• BKCC has a high book value, offering intrinsic value and the ability to pay dividends regardless of stock price, with potential for share buybacks.

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Introduction

BlackRock Capital Investment Corp (BKCC) is a BDC that takes on debt and loans money to middle market companies in order to arbitrage the difference on interest rates. BKCC is a relatively small company, with a market cap of just 240m, yet it lies in a position to capitalize greatly on stabilizing interest rates. The main attraction of BKCC is that BKCC is priced as if it were a dividend trap, which it appears to be on the surface, with a payout ratio of 277%, at first glance well above sustainable, however this isn't the case. This may appear significant enough to call the stock a value trap, but BKCC's earnings are likely to increase a tremendous amount, the net value of its portfolio is 31% higher than its current price, and coupling that with the fact that your average BDC is designed to pay a hefty dividend yield at the cost of price appreciation, and you get a severely misunderstood company that is a definite buy.

Business Model And Macro Economic Trends

BlackRock Capital Corp is a BDC, meaning it buys up credit while taking on debt, and attempts to make a profit on the difference in the interest rates of the two, a job which is easier and more profitable to do when interest rates are increasing, and/or already high. This increase in interest rates hasn't been properly priced into the company however, as the company is currently trading at just $3.30, down almost 5% since October of 2021, including dividends. This is a horrendous mispricing, and whilst BKCC may have been overvalued in 2020-2021, due to retail driven demand for, put frankly, everything, it doesn't mean that the pendulum must swing so far the other way. It appears that the Fed intends to keep rates above (at the very least) 3% for the next two years, something very beneficial to BDCs. However, BKCC has an advantage that not all BDCs have in this higher rate environment, and that is that BKCC's credit has been, in large part, not fixed rate. This means that as rates have been hiked, BKCC's credit has increased its income drastically, while the expenses paid on its debt have not been increased. The table below from BKCC's 2020 Q2 10-Q shows their expected next investment income based on different interest rate changes.

According to BKCC's 10-Q for quarter two of 2023 , "At June 30, 2023, 99% of our yielding debt investments, at fair value, bore interest based on floating rates, such as LIBOR, SOFR, or the Prime Rate." This demonstrates the benefits reaped by BKCC throughout the period of rising rates, something that the market has failed to price into BKCC, leading to an opportunity for investors willing to take the risk.

Portfolio

BKCC's portfolio is made up of debt they take on, in order to purchase credit and make the difference in arbitrage. BKCC's portfolio currently yields a hefty 12.8% on average, more than enough to cover its dividend yield (note that this isn't the only number that must be taken into account, as this doesn't account for their expenses).

BKCC's credit consists mainly of first lien loans , meaning that their credit is a higher priority in the event that the company BKCC is loaning to is unable to pay back its other loans. First lien loans even take priority over other senior debt holders. This speaks to the quality of BKCC's portfolio, and along with the diversification of BKCC's credit, the diminished potential for a large sum to be lost through a companies bankruptcy becomes clear.

Dividend Yield

One of the main attractions of BKCC is its hefty dividend yield of 12.2%, however a question that should be asked is how sustainable is it? Looking into where BKCC's dividend comes from, we find that it's pulled directly from their portfolio, something with a very easy to find value. BKCC's portfolio has a Net Value of $314,029,059, $4.33 a share. BKCC pays out $0.4 a share, 1/11th of its net asset value. If BKCC pays out $4.00 over the course of 10 years, we are left with a compounded annual growth rate ((CAGR)) of 6.74% without dividends reinvested, excluding any growth in the stock's price. This sustainability of the dividend is a strong attractive feature with this stock, as it's more than capable of sustaining a strong yield for a long while.

Book/Net Asset Value

Another notable trait in BKCC's investment potential is their portfolio's net asset value. BKCC is a BDC, a portfolio of investments, which means that at any time, they are capable of liquidating their positions for relatively close to their net asset value. This net asset value, divided by the total number of shares, gets you the total value of each share in this portfolio, a value that, as of 2023, sits at $4.33 (Q2 2023) a value 31% higher than their current share price. This offers a great intrinsic value for the company, something that is further backed up by their high dividend yield, which can be pulled directly from this portfolio and given to shareholders as cash, regardless of share the accurate stock price does. If you aren't convinced at this point, think about it this way. BKCC has a portfolio of $314,029,059, or a net asset value of roughly $4.33 a share. This value represents the total assets that BKCC would be sitting on if they decided to sell everything, in other words, its book value. This is where the dividend comes out of, meaning that BKCC can afford to pay its shareholders the dividend for the foreseeable future, regardless of what the stock price does. This is ignoring BKCC's potential growth in the future, a feature of its BDC status, coming into higher rate environments.

Stock Buybacks

BKCC currently has 72.5m shares outstanding, and a market cap of $240m, however the number of outstanding shares has been shrinking in recent years, as BKCC has initiated stock buybacks. Over the past 10 years, BKCC's share count has been volatile, primarily due to their offered DRIP program and convertibles.

I believe that in the event that BKCC's share price holds steady, they will start to increase their share buybacks, as they become more profitable, and start happily snatching up the shares a discounted value, something that will drive up the book value of each share, and in turn lead to a potential increase of their dividend, as it becomes less expensive to do so.

Downside: Potential For Interest Rates To Decrease

One downside to this investment occurs in the event that interest rates start to decrease before the estimated 3 years. Currently, interest rates are at an unsustainable level, according to both the Fed and recent history , so the looming threat of a decrease in interest rates and thus a decrease in earnings looms over all BDCs. This investment is not suggested for the long term, but rather a potential arbitrage opportunity to take advantage of the current difference in net asset value and stock price. This combined with the high dividend yield driving the ability to extract this difference from the stock, allows for a great opportunity to benefit from higher interest rates, but that doesn't make this a buy-and-hold, you will have to time this investment.

Make Sure To Get Out Before Interest Rates Decrease

All in all, this stock offers a decent opportunity to profit from higher interest rates, and to build up your dividend payers in your portfolio, however this position will have to be monitored, and taking profits in the event that this stock reverts to its net asset value of $4.33 or higher, would not be a bad idea.

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