WHF - WhiteHorse Finance: 12% Dividend Yield Consistent Payouts But Stagnating Loan Portfolio Growth

2023-12-19 03:47:53 ET

Summary

• WhiteHorse Finance has a 12% dividend yield and has consistently paid dividends, but the dividend payout has not seen significant improvement.
• The company posted strong Q3 results, beating revenue and EPS estimates, and has a healthy net asset value.
• The growth in the loan portfolio is stagnating, which could affect future growth, but WHF is trading at a cheap valuation.

Investment Thesis

WhiteHorse Finance ( WHF ) is an American business development company headquartered in Miami, Florida. In this thesis, I will discuss its dividend yield at the current price level and its dividend payout consistency. I will also be analyzing its third-quarter results and its future growth prospects, along with its valuation. I think WHF has consistently been paying out dividends and experiencing a growth in investment income, but the loan portfolio growth has been stagnating, which could affect its future growth. Hence, I assign a hold rating for WHF.

Company Overview

WHF is an externally managed, closed-end, non-diversified management investment company treated as a business development company under the Investment Company Act of 1940. It is primarily focused on originating senior secured loans to lower middle market companies with individual enterprise values between $50 million and $350 million. Its lending in growth capital industries ranges from $5-$25 million, with an average debt investment size of $7.4 million.

12% Dividend Yield

On November 9, 2023, the company announced a quarterly dividend of $0.385 , reflecting a forward dividend payout of $1.54 and an annualized dividend yield of 12% at the current share price of $12.84. As per my analysis, this is its 41st quarter of continuous dividend payment, and during all these quarters, the regular quarterly dividend payout never saw a decline. Even during COVID-19, it consistently paid dividends, reflecting its commitment to returning profits to shareholders in the form of dividends. However, the dividend payout has not seen any significant improvement, with quarterly dividends stagnating at $0.355 from 2013 till the start of 2023. Recently, the company has seen an 8.4% increase in quarterly dividend payout from $0.355 to $0.385.The primary reason behind the dividend payout being flat for such a long time was low net income growth. As late as Q4 FY22, the core net investment income stood at $0.34, and the dividend payout was $0.355, reflecting a payout ratio of 105%, which leaves no room for an increase in the payout. However, in Q3 FY23, it reported a core net investment income of $0.47, which provided the company with funds to increase the dividend payout to $0.385, with a payout ratio of 82%, which I believe is a healthy payout ratio. I believe it is a great investment opportunity for investors looking for a steady dividend return, but I do not see any upside in dividend payout in the coming quarters.

Q3 FY2023 Result

WHF posted strong third-quarter results, beating the market revenue and EPS estimates by 2.5% and 2%, respectively. It experienced a significant increase in investment income. One thing that I found most impressive was that it managed to keep the payment-in-kind in control, which generally represents an income in the form of equity or another instrument, usually in case the client doesn't manage to pay the debt installments in time. We were expecting a higher-than-usual increase in payment-in-kind, given a slowdown in the market, but the company managed to keep it in check. It reported a net asset value ((NAV)) per share of $13.87. This is an important parameter when assessing business development companies, and generally, a price/NAV ratio below 1x signifies that the company has a healthy asset balance. In the case of WHF, the ratio is 0.92x, which signifies it is undervalued with respect to its net asset portfolio.

It reported total investment income of $25.8 million , up 20% compared to $21.5 million in the same quarter last year. I believe the primary income driver was interest income, which saw a positive impact of a higher spread in the loan interest rate since the start of Q2 FY23. The expenses for the quarter saw a jump of 27% from $11.6 million to $14.8 million, primarily driven by increased Performance-based incentive fees. To keep the incentive fees in control, the management has revised the incentive structure and changed the fees from 2% to 1.75%; I believe this move will surely benefit investors in the coming quarters. The net investment income stood at $10.8 million, compared to $9.7 million in the same quarter last year. This represents an EPS of $0.46. However, the company incurred $5.4 million in adjustments in investment value from its non-core business. If we include this adjustment, the net income comes out to be $5.6 million, representing a diluted EPS of $0.24. The adjustments are unrealized losses and don't have any material impact on its cash flow.

Now, let us have a look at its balance sheet. As of September 30, 2023, it reported cash and cash equivalent of $29.7 million against long-term debt of $398 million. It ended the quarter with a net leverage of 1.16x. I do not see any significant issue with its balance sheet. It managed to bring down the leverage ratio from 1.25x to 1.16x, which I believe is a safe multiple for WHF.

Overall, the company experienced significant growth in net investment income and managed to maintain a healthy NAV. One thing that I found missing was growth in the loan portfolio. As we can see in the chart above, the investment portfolio has been consistently dipping. Without a growth in the loan portfolio, the investment income will soon start to stagnate. The company has not provided any future guidance, but it expects FY24 to be a challenging year with the US economy possibly slipping into recession and an expected slowdown. This is reflected in the market estimates for Q4 FY23, with revenue estimated to be $25.19 million and net investment income per share at $0.46. These numbers highlight the fact that both the revenues and earnings are expected to remain flat q-o-q. The dropping portfolio value, coupled with challenging market conditions, could result in deteriorating performance for the company. This is the main reason behind my assigning a hold rating despite a strong third-quarter performance.

Valuation

WHF is currently trading at a share price of $12.84, a YTD increase of 0.5%. It has a market cap of $300 million. It is trading at a forward non-GAAP P/E multiple of 6.95x with an FY23 EPS estimate of $1.85. Comparing this to the sector P/E of 10.5x, I believe it is trading at a cheap valuation at current price levels. But these multiples could soon change if the company doesn't manage to increase its investment income in FY24. I believe the current valuation gives comfort to existing investors who can hold the stock for a 12% dividend yield but initiating a fresh buying position is not advisable.

Conclusion

WHF has been consistent in dividend payouts to shareholders over the past ten years. It posted strong third-quarter results with increased investment income and an impressive NAV of $13.87. However, the growth in the loan portfolio remains the pain point, with no significant growth prospects in the coming quarters. It is trading at a cheap valuation, and investors looking for steady dividend income can stay invested in the company. Considering all these factors, I am assigning a Hold rating for WHF.

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