2023-08-18 09:15:00 ET
Summary
- The business development company, or BDC, industry offers opportunities for investors looking to benefit from rising interest rates.
- PennantPark Floating Rate Capital is a BDC that focuses on lending money to privately held companies with co-sponsors such as VC groups and hedge funds.
- PennantPark Floating Rate Capital's portfolio consists of a mix of debt, equity, and loan investments, primarily in the U.S., with a weighted average yield of 12.4%.
Looking to benefit from rising interest rates?
You may want to check out the business development company industry. These companies are known as BDCs. They lend money to privately held companies, which also have co-sponsors, such as VC groups and hedge funds, with much larger stakes in the underlying companies,
Profile:
PFLT make secondary direct, debt, equity, and loan investments. It focuses on companies that are owned by established middle market private equity sponsors with a track record of supporting their portfolio companies.
The fund seeks to invest through floating rate loans in private or thinly traded or small market-cap, public middle market companies. It primarily invests in the US, and to a limited extent non-U.S. companies. The fund typically invests between $2M to $20M.
PFLT also has a JV - PSSL, a Senior Secured Loan Fund, which was formed in 2017 with Kemper, which owns 12.5% of the JV, while PFLT owns 87.5%, and manages it. As of 6/30/23, 99% of PSSL's investments were 1st lien secured debt.
"PSSL invests primarily in middle-market and other corporate debt securities consistent with our strategy. As of June 30, 2023, PSSL had total assets of $848.4M, and its investment portfolio consisted of debt investments in 105 and 95 portfolio companies. As of June 30, 2023, at fair value, the largest investment in a single portfolio company in PSSL was $17.7 million and the five largest investments totaled $83.7M." (PFLT Quarter Ending 6/30/23 10Q .)
Portfolio:
As of 6/30/23, PFLT's portfolio totaled $1,105.3M, and consisted of $950.2 million of 1st lien secured debt (including $210.1 million in PSSL), $0.1M of 2nd lien secured debt, and $154.9M of preferred and common equity (including $47.9 million in PSSL). The debt portfolio had 100% variable-rate investments.
PFLT's overall portfolio consisted of 130 companies, with an average investment size of $8.5M, and had a weighted average yield on debt investments of 12.4%. The portfolio was invested 86% in 1st lien secured debt (with 19% in PSSL), under 1% in 2nd lien secured debt, and 14% in preferred and common equity (including 4% in PSSL).
As of 6/30/23, PFLT's top 10 industries comprised 58% of its portfolio, with Media and Personal Products each at 8%, down from 7% at 9/30/22. Professional Services decreased from 9% to 7%, while IT Services increased from 6% to 7%. There were similar 1% changes in Commercial Services, Aerospace & Defense, and High Tech. It is invested in 45 industries.
As of June 30, 2023, PFLT had 3 portfolio companies on non-accrual, representing 1% of its overall portfolio on a cost basis, with no new investments on put on non-accrual during the quarter.
Since its inception, PFLT has invested $5.2 billion in 464 companies and experienced only 18 non-accruals, while the loss ratio has averaged 17 basis points annually.
Earnings:
PFLT continues to benefit from rising rates. As of 6/30/23, its weighted average yield to maturity was 12.4%, up from 11.8% in the previous quarter, and 8.5% as of 9/30/22, the end of its fiscal year.
Quarter Ending 6/30/23, Net investment income was $0.36/share, with core NII of $0.31/share. Core NII excludes $0.05/share of one-time dividend income received from PFLT's equity investment in Dominion Voting.
During the quarter ending 6/30/23, PFLT invested $80M in new and existing portfolio companies, at a weighted average yield of 12.5%. The investments in new portfolio companies, had a weighted average Debt/EBITDA of 3.4X, with 2.5X weighted average interest coverage, and a 25% weighted average loan-to-value.
The PSSL JV invested $78M in 6 new and 15 existing portfolio companies at a weighted average yield of 12.1%, including $75M of assets purchased from PFLT.
PFLT's fiscal year ends on September 30th.
Q1-2 '23 (ending 6/30/23): Total Investment Income rose over 43%, and NII jumped ~52%, while NII/Share rose less, over 22%, due to 34% rise in the share count, as PFLT issued new shares, raising ~$100M under its ATM program. NAV/Share was $10.96, down 8.8% vs. 1 year ago. Interest expense rose 40%.
Calendar year 2022: Total Investment Income Revenue rose ~25%, while NII fell 5.3%, and NII/Share was down 13.3%. NAV/Share was down 10.5%, and was $11.30, as of 12/31/23. Interest expense rose 16.5%, to $11.30:
Dividends:
At its 8/16/23 intraday price of $10.56, PFLT yielded 11.36%. It should go ex-dividend next on ~9/16/23, with a ~10/3/23 pay date. Dividend growth has been minimal over the past 5 years, averaging just 0.14%. Distribution coverage is healthy, at 1.11X, over the past 4 quarters.
Profitability & Leverage:
ROA and ROE both increased in the 1st half of calendar year 2023, and were above BDC industry averages. Debt/NAV fell to a very conservative .91X, vs. the industry average of 1.34X, while EBIT Margin also fell from 75% to ~62%.
PFLT's Assets/Debt ratio has improved a great deal so far in calendar year 2023, rising to 2.14X, vs. 1.8X at 12/31/22. EBIT/Interest coverage was steady, at 2.5X:
Debt & Liquidity:
PFLT has a multi-currency Credit Facility with affiliates of Truist Bank, of $366M with an interest rate spread above SOFR (or an alternative risk-free floating interest rate index), of 236 basis points, a maturity date of August 2026 and a revolving period that ends in August 2024.
The Credit Facility had a weighted average interest rate of 7.5%, as of 6/30/23. PFLT had $301.6M of unused borrowing capacity under the Credit Facility. It raised $99M of equity capital under its ATM program during the quarter.
During the period ending 6/30/22, the PSSL JV closed its 2nd CLO financing and the 6th CLO for the PennantPark platform. This CLO financing provided the JV with over $100M of capital for new investments.
Performance:
In spite of its improved earnings, PFLT hasn't gotten as much market support as other BDC's - it has lagged the BDC industry average price performance, and that of the S&P 500 over the past month, quarter, year, and so far in 2023. It has also lagged over the past year on a total return basis.
Analysts' Targets:
UBS initiated coverage of PFLT in June '23, with a Neutral rating, and an $11.00 price target.
At its 8/16/23 intraday price of $10.56, PFLT was 4% below that $11.00 target, and 8% below the average $11.50 price target.
Valuations:
At $10.56, PFLT was selling at a 3.65% discount to its 6/30/23 NAV of $10.96, vs, the BDC average discount of 3%. This is a much lower discount than PFLT's 6/23/22 14.26% discount. While its P/Sales is much lower than the BDC average, its earnings multiple, P/NII per share of 9.03X is roughly in line with the industry's 8.9X average, and its EV/EBIT is a bit higher than average.
Parting Thoughts:
PennantPark Floating Rate Capital (PFLT), like other BDCs, continues to benefit from rising rates, with improved earnings. However, Mr. Market doesn't seem to care. One thing we've noticed while covering PFLT is that its price performance tends to lag that of the BDC industry.
While we applaud PennantPark Floating Rate Capital's improved earnings, its lagging price performance makes us leery of buying shares at this point.
If you're interested in other high yield vehicles, we cover them every Friday and Sunday in our articles.
For further details see:
PennantPark Floating Rate Capital: Floating Rate 11% Yield, Earnings Up, But...