2023-11-17 08:00:00 ET
Summary
- Crescent Capital is a high-yield, quality investment option for income investors.
- CCAP has a well-diversified portfolio with investments in various industries and diversification outside of the U.S.
- The company has a conservative dividend policy and a strong balance sheet, making it resilient in the face of economic downturns.
- The BDC is one of the few who trades at a discount to its NAV, and offers investors an upside to its price target.
- In the higher for longer environment, rises in PIK income and non-accruals will continue to be a headwind going forward.
Introduction
Although bonds seemed to have tapered off a bit over the last few weeks, many investors have elected to park their cash in these fixed-rate investments until the economy stabilizes. There still seems to be a lot of uncertainty surrounding the market, even though it appears to have eased a bit since the last FED meeting. But there are still things to worry about in the coming year such as the "higher for longer" environment promised and the looming recession. So as investors, you have to ask yourself. Would you rather get a 5%-6% return on your investment? Or would you rather get a near double-digit yield along with some specials and/or supplementals to boost your income? One BDC that offers that is Crescent Capital ( CCAP ). Not only does this BDC offer a high yield, it provides investors with a quality business that can be held for the long-term. Let's get into why income investors should consider CCAP for their portfolios.
Who Is Crescent Capital?
CCAP is a fairly new BDC having IPO'd right before the COVID-19 pandemic in 2020. This was after they announced the merger with Alcentra Capital Corporation, an externally managed, middle-market BDC. Since then, the company has been steadily growing its portfolio and now has 185 companies representing a total value of $1.6 billion. Since 2020, their portfolio value has doubled from $883 million. Additionally, they've invested in nearly 60 additional companies in the last few years. Similarly to several of its peers in the sector, they also focus primarily on the Healthcare, Software, and Commercial & Professional Services.
And they are also diversified across 20 industries. Most of their investments are here in the U.S. with 88.5%, but they're also diversified outside of the United States with 6.8% of their investments in Europe, and 2.3% in Canada. Additionally, they have 2.4% in Australia and New Zealand. This is in comparison to their largest peers Ares Capital ( ARCC ) and Blue Owl Capital ( OBDC ), who have 6% and 8% international exposure respectively.
They're also defensively positioned with 89% of investments in first-lien, senior secured debt. 99% of their debt investments are floating rate so a higher for longer environment will continue to benefit CCAP for the foreseeable future. This is also important because it offers downside protection and lower risk of loss if the economy does experience an unexpected downturn, or a recession which is expected sometime in the near future.
Conservative Dividend
Similar to ARCC, CCAP has elected to be more fiscally conservative since going public. Since 2020, they have kept the dividend steady at $0.41 for 20 consecutive quarters but have paid out specials and supplementals. But they have been steadily growing net investment income, out-earning its regular and supplemental dividends in the process. From Q1 to Q3 total investment income grew nearly 23% from $39.28 million to $48.2 million. Quarter-over-quarter they managed to grow their income from $46.7 million. By increasing their investment income and out-earning their dividend, this has allowed them to grow their NAV price as well. This increased $0.12 to $19.70 from Q2 to Q3, and a 1.6% increase from $19.38 in Q1.
During Q3 earnings, which CCAP reported earlier this month, management raised the supplemental dividend by a penny to $0.09, which is payable next month. During the quarter they also closed on 3 additional investments for a total of $45 million. $20 million in new investments and $25 million towards existing portfolio companies. 99% were senior secured, first-lien unitranche investments. Management also expects to see a continued uptick in 2024 M&A activity. Furthermore, they expect that their focus on sponsor-backed opportunities, and their deep relationships in the space positions them to benefit from this.
Balance Sheet Health
In my opinion CCAP has one of the stronger balance sheets in the BDC sector with no debt maturities due until early 2026. They've also managed to decrease their debt-to-equity ratio from 1.23x to 1.18x this year. Furthermore, they have $370 million of undrawn capacity and $22.8 million in cash & cash equivalents at quarter end. This level of dry powder allows the company to make selective investments in new opportunities going forward. Ample dry powder also allows businesses to support existing companies if they run into unexpected trouble. So, investors don't have to worry about the company having to refinance any of their debt at higher rates in the near term. And even then, I expect rates to be significantly lower by 2026.
Valuation
At the time of writing CCAP trades at nearly a 19% discount to its NAV price of $19.70. They also offer 6% upside to its price target of nearly $18. If you're looking for a greater margin of safety, I suggest waiting for a pullback to around $15 or lower. With the banking crisis earlier this year leading to stricter lending standards, BDCs are now positioning themselves to be long-term investments. And even when rates begin to come down sometime in the near to medium-term, I expect them to hold up well. As CCAP continues to grow and out-earn its dividend, I expect them to continue growing their share price and I can see this reaching over $20 in the coming months. Investors with a buy-and-hold mentality could be getting this fairly newcomer at a significant discount if you believe in its outlook.
Risk Factors
The current macro environment has put downward pressure on many BDC portfolio companies. And although BDCs have benefited from this due to their floating rate debt investments, the higher costs of borrowing will continue to be a headwind going forward. CCAP's management stated during recent earnings that they continue to monitor portfolio companies. That's why portfolio diversification and ample liquidity remains an important factor when looking to invest in this sector as their borrowers will continue to face pressure.
If rates do indeed remain higher and/or the FED decides to raise rates in the near future, the risk of loan defaults will likely rise further. At quarter end CCAP had a total of 9 portfolio companies on non-accrual status, representing 2.3% and 1.8% of total investments at fair cost and value. Another risk is a rise in PIK income. CCAP reported this represented a modest portion of revenue and 2% total investment income. But management stated this remains one of the lowest levels in the BDC space. Going forward portfolio diversification & geography will be key factors for BDCs, and selective investments in market-leading companies with high FCF generation and strong margins will play a significant role in their ability to continue growing.
Conclusion
Although they don't have a track record as long as some of its peers, CCAP is a stellar BDC that has a well-diversified portfolio. Additionally, they've shown resilience by investing in market-leading companies and have one of the stronger balance sheets in the entire sector with no debt maturing until 2026. Since going public they've managed to double their portfolio value and I expect this to continue going forward. Management also appears to be conservative, which I think is important with an expected recession looming. This conservatism along with their ample liquidity will help management navigate any downturns or financial pressure from companies within their portfolio. Furthermore, they trade at a double-digit to its NAV share price, offering investors upside. If you want income for the higher for longer environment, and a potential long-term investment at a bargain, CCAP appears to fit the bill.
For further details see:
Crescent Capital: Forget Bonds, Boost Your Income With This Near Double-Digit Yield