NMFC - New Mountain Finance: A Smart 9.4% Yield For Trying Times

Summary

• New Mountain Finance is a well-managed BDC with a strong track record of NAV per share stability and outsized total returns.
• It's benefiting from rising rates and maintains a healthy portfolio.
• The recent price drop has pushed up the dividend yield to an attractive level.

Falling portfolio values can be disheartening for many investors, including seasoned veterans. It's important, however, to keep in mind that bull markets are "born on pessimism, grown on skepticism, mature on optimism, and die on euphoria", as noted by the late great investor Sir John Templeton.

That's why it's important to keep one's mind focused on creating value for the portfolio rather than over-rotate one's thinking on when the bear market will end. This brings me to New Mountain Finance ( NMFC ), which now sports a dividend yield well above 9%. This article highlights why the latest dip presents a solid buying opportunity for income investors, so let's get started.

Why NMFC?

New Mountain Finance Corp. is an externally managed BDC that was founded during the Great Financial Crisis in 2008 and became publicly-traded in 2011. It's externally managed by New Mountain, which is an alternative investment firm that manages private and public equity, and credit funds with more than $37 billion in assets under management.

NMFC carries a diverse portfolio with a fair market value of $3.1 billion, spread across defensive and growing sectors, with enterprise software, healthcare, and business services being its top 3 segments. As shown below, NMFC's remaining segments are comprised of economically essential segments such as education, net lease, and distribution.

NMFC's portfolio is also faring well amidst market volatility, with NAV per share declining by just 1% ($0.14) on a sequential QoQ basis to $13.42 at the end of the second quarter. I'm not concerned by this slight decrease in NAV, as it was due primarily to broad market movements, partially offset by a $0.13 net NAV/share increase on NMFC's portfolio.

Moreover, NMFC is benefiting from the rising rate environment, as it now generates a 10.3% yield on cost, sitting 150 basis points higher than 8.8% from the prior year period. This was one factor in enabling NMFC to generate NII per share of $0.31, which more than fully covered its $0.30 quarterly dividend.

In addition, the overall portfolio is rather healthy with 91% of investments being rated green (its lowest risk rating). The percentage of investments in the lowest red and orange positions also declined from 8.4% of the portfolio in the first quarter to just 2.4% at the end of Q2. Investments on nonaccrual also remain low, representing just 1.36% of the portfolio fair market value.

Risks to NMFC include its lower exposure to first lien investments (56% of portfolio) than some of its peers. However, this percentage moves up to 68% when NMFC's senior loan programs and net lease investments are included. In addition, NMFC's 2nd lien debt (18% of portfolio) provides higher yields and its 7% exposure to common equity gives it NAV upside potential.

NMFC is clearly a company that's weathered through economic cycles rather well, by keeping a rather steady NAV per share over the past decade. This has enabled NMFC to produce a 198% total return in the 10 years leading up to the end of May, far surpassing the 73% of the Credit Suisse High Yield Index and the 66% BDC sector average.

Looking forward, NMFC remains well positioned for rising rates, as 89% of its debt investments portfolio is floating rate, while just 46% of its borrowings are floating rate. It also maintains reasonable leverage with a statutory debt to equity ratio of 1.27x, sitting comfortably below the 2.0x regulatory limit. Deal activity may not be as high as what NMFC saw during the go-go days of second half 2021, but there remain attractive opportunities, as highlighted by management during the recent conference call :

Our strategy of making loans to non-cyclical defensive businesses provides added margin of safety compared to that of the overall lending market. While new deal activity remains materially lower than the latter half of 2021, we continue to see compelling investment opportunities in a market where spreads are at least 100 basis points wider than they were at the beginning of the year. The deal structures of most new direct loan investments remain attractive with sponsor equity contributions consistently in the 60% to 80% range.

Finally, it is important to highlight that the overall direct lending market continues to take meaningful share from the syndicated loan and high yield bond asset classes as our private financing solutions offer an ease of execution, price clarity and capital certainty that is not currently available in these other markets.

Lastly, I find good alignment of interest between NMFC and its shareholders, with employees owning 12% of the outstanding shares. I see value in the stock, especially after the recent drop to $12.80, equating to a 5% discount to book value. As shown below, NMFC has generated at a slight premium to NAV over the past 3 years outside of the 2020 timeframe. Sell side analysts have a consensus Buy rating with an average price target of $13.67. This translates to a potential one-year 16% total return including dividends.

Investor Takeaway

New Mountain Finance is a well-managed BDC with a strong track record of NAV per share stability and outsized total returns. It continues to generate good income for shareholders as well as attractive risk-adjusted returns. While the stock may not be dirt cheap at current levels, I believe it represents a good value after the recent drop for potentially strong long-term income and returns.

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