2023-07-07 10:24:19 ET
Summary
- Bain Capital Specialty Finance is paying an 11.2% forward annualized dividend yield.
- Its portfolio had a fair value of $1.12 billion at the end of its first quarter, with the BDC currently trading at a 28% discount to its NAV.
- Net investment income for the first quarter grew by 47% over its year-ago comp and covered the most recent dividend by 132%.
Bain Capital Specialty Finance ( BCSF ) last declared a second quarterly cash dividend of $0.38 per share for an 11.2% forward annualized yield. This payout was in line with its prior distribution but came on the back of what was a 6% raise for the first quarter dividend. The first rule of income investing is to avoid yield traps and whilst a double-digit yield is not atypical, BCSF has had a relatively disrupted history, with its net investment income sometimes barely covering its dividend payout. The business development company slashed its dividend by $0.07 during the onset of the pandemic, with the recovery since then yet to place the quarterly payout beyond this level. However, the current payout is secured against a net investment income that came in at $0.50 for BCSF's fiscal 2023 first quarter.
The BDC is externally managed by a subsidiary of Bain Capital Credit, a global credit specialist with $41 billion in assets under management. BCSF's portfolio as of the end of its first quarter had a fair value of $2.42 billion and was comprised of investments in 138 portfolio companies operating across 30 different industries. This formed a net asset value of $1.12 billion as of the end of the first quarter, around $17.37 per share, up around $0.08 sequentially from the fourth quarter. Crucially, BCSF is currently swapping hands for $13.56 per share, around a 28% discount to its NAV.
Discount To NAV Presents Upside Potential
Whilst being able to purchase BCSF for what's 72 cents on the dollar, it's important to understand why the BDC trades for a discount. Indeed, the BDC has historically traded at a discount since the 2020 dividend cut. The gap widened in 2022 on the back of shareholder concerns around the dividend payout ratio that was as high as 100% last year. Hence, the discount is somewhat retrospective in nature, as it looks back to a time when the BDC's performance was poor, and it struggled to maintain its dividend against net investment income.
BCSF is now on the offense, investing $308 million in 52 portfolio companies during the first quarter. This included $116.1 million in six new companies. The BDC also received $285.4 million in principal repayments and sales during the quarter, for a net investment funding of $22.6 million. BDC ended the first quarter with cash and equivalents, including restricted cash, that at $81 million was around 9% of its market cap. This is important as it reduces the inherent volatility of NAV to help partially mitigate bearish concerns that the current discount could be tightened by NAV falling rather than the stock price moving up.
Bain Capital Specialty Finance Fiscal 2023 First Quarter Presentation
The portfolio had a 12.3% weighted average yield at amortized cost as of the end of the first quarter, with two portfolio companies on non-accrual representing 0.6% of the total portfolio. Equity formed around 14% of the portfolio at fair value as of the end of the first quarter with first lien debt at 66%, down around 400 basis points from the prior fourth quarter. This decline in first lien exposure was due to the growth of investment vehicles, which comprised 14% of the investment portfolio. Crucially, 95% of the underlying investments held in these investment vehicles were comprised of first lien loans, meaning a look through first lien portfolio exposure of 82%.
Geographic Diversification Reduces Risk As Investment Income Surges
BCSF is also relatively unique in that it is not a purely US-focused BDC, with Europe and Australia forming 14% of its portfolio. Overall, the diversification, an ending debt-to-equity ratio of 1.19x, and a high cash position render BCSF less risky than the implications of its current discount to NAV. Bears would be right to flag that the discount to NAV could remain against a still uncertain macroeconomic backdrop, with inflation still being roughly double the Fed's 2% target and against what were ten consecutive interest rate hikes up until the pause in June.
Bain Capital Specialty Finance Fiscal 2023 First Quarter Presentation
The Fed has been clear that they see the possibility of more rate hikes this year as the specter of a hard landing haunts the global economy. Hence, whilst floating rate loans form 94.3% of the portfolio to hedge their exposure to rising rates, the BDC's NAV discount could remain sticky in a scenario where inflation came in worse than expected to force further 25 basis point rate hikes. Total investment income of $74.7 million during the first quarter, rose 19.7% sequentially to drive net investment income of $32.2 million, around $0.50 per share. This was up 35% quarter-over-quarter and 47% year-over-year to form 132% coverage against the current dividend payout. Spillover income per share was $0.44 as of the end of the quarter, with BCSF guiding for continued NII in excess of dividends. Hence, shareholders might be in line for another dividend raise if the macroeconomic backdrop permits it. BCSF is a buy against this.
For further details see:
Bain Capital Specialty Finance: The Fat 11.2% Yield Is Secured