WHF - WhiteHorse Finance: Compelling Dividend History But Untested By A Recession

2023-09-27 06:26:13 ET

Summary

• WhiteHorse Finance is a business development company that offers loans to private American companies with valuations between $50 million and $350 million.
• The company's business model is untested in a recessionary environment, making it a speculative play especially considering that it makes loans to companies without good credit ratings.
• WHF offers a consistent 12% dividend yield and is likely to perform well as long as conditions remain favorable.

WhiteHorse Finance ( WHF ) is an externally-managed and closed-end business development company that offers loans to private (i.e., not publicly traded) American companies whose valuations range from $50 million to $350 million. The company also owns 66% of a joint venture with State Teachers Retirement System of Ohio which also operates like a BDC. There are many things to like about this company such as its cheap valuation, stable distribution history but it's also worth noting that the company has a relatively short history and its business model is untested in a recessionary environment which makes it somewhat a speculative play especially considering the types of loans it makes.

The company uses first lien and second lien type of loans (backed by real assets) at floating rates to generate a profit from rate spreads (the difference between the rate it can borrow and the rate it can loan out money) which can also fluctuate from day to day. To make the matters more complicated, the company mostly offers loans to companies whose debt is either rated below investment grade (often called "junk") or no rating at all which makes it a speculative play. This is especially important to know because the company has been around since 2011 so we don't exactly know how it would perform during an event like the 2008 recession. Since the company's entire existence was during a bull market, favorable economic conditions and extremely accommodative Federal Reserve (well until last year), it is difficult to predict how it will do when conditions are not as favorable.

Having said that, this company offers a well-covered 12% dividend yield and investors with strong risk appetite and thirst for income might find value in this company. Since inception, the stock's price is down slightly (about -13%) but it's total return is up close to 200% entirely driven by dividends. Then again since this company is legally recognized as an investment company under the Investment Company Act of 1940, it has to distribute virtually all of its profits to shareholders so I am not surprised that all of its returns came from dividends. The fact that the stock held on during this time is somewhat assuring since we've seen so many high-yielders have their NAV erode drastically over the years (especially mortgage REITs) by 50% or more. If a stock that yields +10% drops only -13% in more than a decade, I might call it a win at this point. Then again keep in mind that this company has never seen a recession so its performance might not be as good under less ideal conditions.

When it comes to this company's distribution history, one thing you can say about it (besides it having a high yield) is that it's been very consistent over the years. Since its inception, the stock has been paying about 30-40 cents per share per quarter. Dividend hikes have been almost non-existent with this company but you can also say the same about dividend cuts. You can rely on this company to pay about the same year after year as long as business conditions remain favorable.

Even though there isn't much of dividend hikes, you can create your own hikes by reinvesting all or some of your distributions. For example if you had bought $10k worth of WHF exactly a decade ago, held until today and reinvested your dividends (assuming in a tax sheltered account such as a 401k) your annual income would have grown to $2,740 indicating a yield of 27.4% against your original investment. This is a well-known phenomenon called "power of compounding".

The company trades at a price to book value ratio of 0.866 indicating a 13.4% discount against its book value. Having said that, we should also note that the company's book value has been declining for the last couple years but this shouldn't surprise anyone since bond market has been in a bear market since late 2021 due to rates going higher in order to curb inflation. I would actually say that the fund's book value is holding up well and it's only down about 10% from its peak while many bonds and bond funds are down by much more. This could be because the majority of the loans issued by WHF are shorter term loans with maturities ranging from 1 to 5 years and those tend to lose less value as compared to longer term bonds or debt instruments when yields are rising.

Consensus estimates call for the company earning $1.85 this year and $1.73 next year which means that the company trades for a forward P/E of 7 for the next 2 years. It also indicates that the company can easily cover its annual distribution of $1.50 as long as it meets those numbers but there will not be much room for a dividend hike unless the company can beat these estimates by a large margin.

Historically speaking the company has a history of either meeting estimates or slightly falling behind (by 3-4%) but its earnings beats are very rare. In the below chart dark bars represent actual earnings and blue bars represent estimates where you can see how it performed in the last 10 years. I wouldn't bet on them beating estimates this year considering the inverted yield curve we are seeing in bond markets.

So, what's the final verdict on this company? It really depends on who you are, what your goals are and how much risk tolerance you have. I am inclined to say that this stock warrants a look and it wouldn't hurt to initiate a small position but make sure that your position is not too large. You can start a position that's as small as 1% of your total portfolio value and reinvest dividends along the way to grow your position over time. If this stock performs well, its weight in your portfolio will keep growing which is a good thing. If the stock performs badly, your losses will be limited. This is especially true in this environment with so much uncertainty and the Fed suddenly turning from super-accommodative to super-unfriendly. This puts us in uncharted waters and no one knows what's coming next. At uncertain times, you want to limit your exposure to stocks like this one which relies on small companies whose credit rating is below investment grade and badly in need of capital. When capital markets dry up, these are the first companies that have the risk of going under and you don't want to be caught holding a large position of that.

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