FSK - FS KKR: A Fat 14.2% Yield For 79 Cents On The Dollar

2023-07-16 10:03:07 ET

Summary

• FS KKR is paying a 14.2% annualized forward dividend yield and $0.15 in special dividends through 2023.
• The BDC is currently swapping hands at a 21% discount to NAV per share.
• Net investment income growth barely registered any growth with just $6 million in net investment during the quarter and against a rise in loans on non-accrual status.

FS KKR ( FSK ) is bursting at the seams with income. The business development company last declared a quarterly cash dividend of $0.70 per share , in line with its prior payout and for a huge 14.2% annualized forward dividend yield. The BDC will also be distributing a $0.15 special dividend for a 0.76% implied incremental annualized forward yield. Hence, FSK is currently sporting an aggregate dividend yield of around 14.96% against specials set to be paid out through 2023. This is one of the highest aggregate yields I've seen from a BDC as is set against common shares that are currently trading at a 21% discount to its NAV per share of $24.93 as of the end of its fiscal 2023 first quarter. If income is the prize then FSK has seemingly etched its name into the BDC all-star list. What's the catch?

That the commons are down 35% over the last 5 years and have generally trended down over the last decade. Whilst they're up 11.5% on a total return basis over this time frame, FSK has historically struggled to expand its net asset value on a nominal and per share basis. The Philadelphia, Pennsylvania-based BDC is externally managed by FS/KKR Advisor, a partnership between KKR Credit, a subsidiary of KKR & Co. ( KKR ), and FS Investments. It's the second-largest publicly traded BDC platform in the market with a $15.3 billion investment portfolio at fair value. This came with an 11.7% weighted average annual yield on accruing debt investments during the first quarter, up 30 basis points sequentially from the fourth quarter. Critically, around 89% of FSK's debt investments were floating rate and 69% was invested in senior secured securities.

Net Asset Value Trendline

This mix of first-lien senior secured loans under floating rates has placed the BDC in a strong position to benefit from a Fed funds rate hiked ten times up until the June FOMC meeting to its highest level since 2008 at 5% to 5.25%. Rates could yet go higher with comments from the Fed stating the possibility of two more rate hikes in 2023 even as June CPI numbers came in below expectations at 3%. This elevated interest rate environment could help drive strong total investment income generation with rates not slotted to start coming down until the end of the first half of 2024.

The NAV has been trending lower since the summer 2021 merger between two previously separate BDCs; FS KKR Capital Corp. and FS KKR Capital Corp. II. NAV, as expressed by tangible book value, was $6.98 billion, around $24.93 per share, for the first quarter. This was down sequentially from $7.01 billion in the fourth quarter. However, the BDC's weighted average shares outstanding actually fell quarter-over-quarter to allow NAV per share to expand by $0.04 from $24.89 in the fourth quarter.

Dual Beats Drives Healthy Dividend Coverage

This reduction came on the back of a now-completed $100 million buyback program that saw $32 million of shares purchased during the first quarter. This was set against $270 million of new originations during the quarter with repayments at $264 million. The BDC's net debt-to-equity ratio at 118% was unchanged versus the fourth quarter with FSK recording a total investment income of $456 million , up 15.2% over its year-ago comp and a beat by $11.56 million on consensus estimates.

Net investment income expanded by $9 million over its year-ago comp. On a per-share basis, it grew by 1 cent to $0.81 to cover the most recent regular dividend by 115.7%. Critically, this pace of NII growth pales in comparison to the broader BDC space where floating-rate loans have driven more marked year-over-year growth rates. Loans on non-accruals were 5.5% of FSK's portfolio on a cost basis and 2.7% on a fair value basis. This was up sequentially from 4.9% and 2.4% respectively in the fourth quarter. Whilst the dividend yield is fat and set against a huge 21% discount to NAV, the BDC might need to ramp up investments to better take advantage of the current macroeconomic environment.

Interest rates are set to be higher for longer and a net portfolio increase of $6 million during the first quarter is simply too small to move NII in the direction that would potentially offset a rise in non-accruals if the economy dips into a recession. However, this cautiousness might be warranted to reduce FSK's overall exposure in the event of a hard landing. The BDC ended the first quarter with $3 billion in available liquidity. Overall, I'm neutral on FSK here. The fat dividend yield and discount to NAV are positives from an investability perspective, however, the meager rate of NII growth and the growth of loans on non-accruals provide two reasons to pause.

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