BKCC - BlackRock Capital Investment: Get An 11% Yield At A Discount To NAV

Summary

• BlackRock Capital Investment’s portfolio is growing.
• Focus on senior secured debt provides downside protection.
• 23% NAV discount compensates for high pay-out ratio.

BlackRock Capital Investment Corporation ( BKCC ) remains appealing to passive income investors as a business development company and high yield investment.

The BDC is trading at a significant discount to its net asset value, and it has a strong First and Second Lien focus, which provides principal protection to the company and its investors during an economic downturn.

BlackRock Capital Investment is experiencing strong portfolio growth as well, and the BDC improved the quality of its portfolio in the third quarter by originating almost entirely in new First Liens.

Portfolio Has A Substantial First Lien Focus

BlackRock Capital Investment is an externally managed business development company managed by a wholly owned subsidiary of BlackRock, one of the world's largest asset managers.

BlackRock Capital Investment has developed a strong preference for senior secured debt, primarily First and Second Secured Liens, which provide passive income investors with a high level of capital protection.

BlackRock Capital Investment had 77% of its net assets invested in First Liens and 17% in Second Liens as of the end of the September quarter, giving the business development company a 94% investment exposure to secured and highly rated First and Second Liens. In addition, BlackRock Capital Investment invested $35 million (6%) of its total portfolio in unsecured debt and common and preferred equity.

As shown in the portfolio breakdown below, BlackRock Capital Investment is primarily invested in Diversified Financial Services (15%), Software (13%), and Internet Software & Services (11%), all of which are relatively recession-proof industries.

The portfolio of BlackRock Capital Investment increased by $17.2 million to $574.6 million at the end of the third quarter. Before repayments, the business development company made $78.0 million in new investments in the third quarter, all of which (99.9%) went to highly rated Senior Secure First Lien Debt. The repayments totaled $60.8 million, with 5 full repayments from existing portfolio companies.

The number of portfolio companies is also increasing (from 100 in 2Q-22 to 111 in 3Q-22), indicating that BlackRock Capital Investment's diversification is improving.

Dividend Coverage Is Not Great, But Is Improving

In the third quarter, BlackRock Capital Investment earned $0.10 per share in net investment income, which was enough to cover the $0.10 per share dividend payment.

The pay-out ratio in the previous twelve months was 108%, indicating that the BDC paid out slightly more than its net investment income.

BlackRock Capital Investment's dividend pay-out ratio has improved in the last three quarters, owing to strong originations and a growing portfolio.

BKCC Can Be Acquired At A 23% Discount To NAV

BlackRock Capital Investment trades at a discount, owing to the company's high pay-out ratio and the portfolio structure shift. The BDC is shifting its portfolio to higher-quality loans, which I discussed previously .

With that said, I believe BlackRock Capital Investment's changing portfolio structure and increased focus on First Liens improves the BDC's overall portfolio quality. As a result, the 23% discount to net asset value appears exaggerated to me, and I consider BKCC a buy primarily because of the large NAV discount.

Why BKCC May See A Lower Valuation

The company's net investment income pay-out ratio is the specific risk with BlackRock Capital Investment. As demonstrated in the second section of this article (dividend coverage), BKCC distributes all of its net investment income, making the BDC vulnerable to a decline in portfolio quality, which could lead to a dividend cut.

My Conclusion

BlackRock Capital Investment is not the best BDC in the world (and certainly has higher risks than the average business development company), but if the price is right, I believe it is worthwhile to give those companies in the sector a chance that are on a good trajectory and are doing the necessary work to improve the quality of their underlying investment portfolios a shot.

Despite the fact that BlackRock Capital Investment paid out 100% of its net investment income in the third quarter, I believe the BDC's 23% net asset value discount makes it appealing to passive income investors.

The shift toward higher quality First Liens and strong originations is also a plus, as it can provide protection during a recession.

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