Scott Kennedy’s BDC Earnings Series: PennantPark Floating Rate’s And MidCap Financial’s Performance For Q1 2024
Summary
PFLT’s NAV slightly-modestly exceeded my/our expectations (top end of range; modest increase) while its NII was a minor underperformance (within range; minor decrease).
PFLT’s minor NII underperformance was partially in relation to its newly-issued debt securitization. However, I was impressed by PFLT’s recent NAV and investment portfolio growth.
PFLT received a 2.5% recommendation range upgrade. PFLT’s risk/performance rating was also upgraded to 3.5. That said, even after these upgrades, PFLT is still deemed modestly overvalued.
MFIC’s NAV matched my/our expectations (well within range; relatively unchanged) while its NII was basically an exact match (well within range; minor decrease). An average quarter in my opinion.
No change in MFIC’s percentage recommendation ranges or risk/performance rating. Even with my/our March 2024 upgrade (due to the pending affiliated merger), MFIC is currently deemed “pricey”/modestly overvalued.
Formatting Change to this Article Series
We have recently changed the format of this earnings-related article series (less wording, more visual images). This process remains ongoing and future changes will likely occur.
1) PFLT:
Commentary
Quarterly NAV Fluctuation: Minor - Modest Outperformance (2.7% Variance).
NII: Minor Underperformance ($0.023 Per Share Variance).
A slightly – modestly outperforming quarter regarding PennantPark Floating Rate Capital’s PFLT 0.00%↑ NAV in my opinion. PFLT reported a minor - modest quarterly NAV increase while I projected a minor decrease. As such, PFLT’s underlying portfolio company valuations (both realized and unrealized) slightly - modestly exceeded my expectations. PFLT reported a combined net realized gain and unrealized appreciation of $12 million during Q1 2024. In comparison, I projected a combined net realized loss and unrealized appreciation of ($5) million. There were a couple modest, positive surprises regarding quarterly FMV fluctuations within PFLT’s 146 portfolio companies during Q1 2024. This included, but was not limited to, By Light Investco LP (“By Light”), Kinetic Purchaser LLC (Kinetic), and Municipal Emergency Services Inc. (Municipal). PFLT also had some very minor NAV accretion from common stock equity raises.
A slightly underperforming quarter regarding PFLT’s NII in my opinion. PFLT reported a minor quarterly NII decrease while I projected a very minor increase. Let us briefly discuss this minor underperformance.
First, when excluding FMV fluctuations, PFLT increased the company’s investment portfolio size by $193 million during Q1 2024. This was due to $338 million of quarterly loan originations which “trumped” ($145) million in prepayments/repayments/exits. This should be considered a large quarterly increase. In comparison, I projected PFLT would increase the company’s investment portfolio size by a mean of $150 million. As such, actually a slightly larger investment portfolio size. So, this factor did not contribute to PFLT’s NII underperformance.
Second, PFLT reported a weighted average annualized yield of 12.50% and 12.30% during Q4 2023 and Q1 2024, respectively (0.20% decrease). This past quarter, this was an underperformance of (0.10%) when compared to my expectations. This was mainly due to PFLT expanding the company’s 1st lien debt investments which inherently carry a lower effective interest rate when compared to say 2nd lien or subordinated loans. This is something that is acceptable in my opinion. Simply put, a bit more safety for a slightly lower yield. As stated 2 quarters ago, I continue to believe this metric began to plateau towards the end of 2023. I continue to project a gradual decrease over time which is already factored in my/our modeling and percentage recommendation ranges. In addition, it should be noted the higher LIBOR/SOFR/PRIME rose (over 500 basis points [bps] in 1.5 years), the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2024. So, these 2 usual factors were part of the cause of PFLT’s minor quarterly NII underperformance (not all of it).
Third, PFLT completed a debt securitization during Q1 2024 regarding the liability side of the balance sheet. Simply put, the 8.1% effective interest rate of this $287 million debt securitization (excluding the subordinated notes which were eliminated in consolidation) was higher when compared to my expectations. In comparison, I projected an effective interest rate of 7.8%. This directly led to PFLT recording higher quarterly interest expense (hence lower NII) when compared to my expectations.
That said, I was pleased with PFLT’s continued NAV and investment portfolio growth. I believe PFLT is one of the few BDC peers who could potentially grow NII during 2024. Along with continued low non-accruals and PIK/deferred income (discussed in a bit), I/we are upgrading PFLT’s risk/performance rating to 3.5.
Change or Maintain
NAV Adjustment: Our projection for current NAV per share was adjusted: Up $0.30 (To Account for the Actual 3/31/2024 NAV Vs. Prior Projection). Price targets have already been adjusted to reflect the change in NAV. The update is included in the card below and the subscriber spreadsheets.
Percentage Recommendation Range (Relative to CURRENT NAV): 2.5% Upgrade (Due to a Projected Potential Increase in 2024 NII from Continued Investment Portfolio Growth).
Risk/Performance Rating: Upgrade to 3.5.
Earnings Results
Note: NAV at the end of the quarter. Subscriber spreadsheets and targets use current estimates, not trailing values.
Valuation
Ending Notes/Commentary
Regarding credit risk, PFLT added 1 portfolio company, Walker Edison Furniture Company, LLC (Walker Edison), to the company’s list of non-accruals during Q1 2024. This was correctly anticipated on my end (as indicated in our weekly mREIT/BDC article series; credit section). In addition, 1 portfolio company, Mailsouth Inc. (Mailsouth) was taken off non-accrual status and/or was exited/written-off/restructured during the quarter. PFLT wrote off the company’s very minor 2nd lien debt investment in Mailsouth (less than $1 million) during the quarter.
As of 3/31/2024, PFLT only had 1 portfolio company on non-accrual status (net unchanged when compared to 12/31/2023). When calculated, non-accruals accounted for only 0.4% and 0.3% of PFLT’s investment portfolio as of 3/31/2024 when based on amortized cost basis and FMV, respectively. Both percentages very slightly increased when compared to 12/31/2023 but will remain below sector averages as of 3/31/2024. That said, it should be noted PFLT fairly recently restructured several previously non-accrual portfolio companies. Simply put, not the best outcome regarding lowering non-accrual percentages/putting portfolio companies back on accrual status. I continue to anticipate a general rise in credit risk during 2024 – early 2025. At this point in time, just something to keep note of. Credit risk will remain a key metric to track over the foreseeable future.
Regarding dividends, earlier this month PFLT declared an unchanged monthly dividend of $0.1025 per share for May 2024 while continuing to not declare a special periodic dividend. Both dividend declarations were within my projected range. I continue to anticipate, at worst, an unchanged base monthly dividend of $0.1025 per share through, at the earliest, the remainder of 2024. PFLT continued to have a modest cumulative UTI balance as of 3/31/2024.
I was also pleased PFLT’s capitalized PIK/deferred income percentage slightly decreased from 2.28% during Q4 2023 to 1.77% during Q1 2024. This percentage remained modestly below the sector average. A BDC having a rapid increase in, or continually elevated amounts of, capitalized PIK/deferred income, as a percentage of total investment income, is a negative catalyst/trend (something I have pointed out since 2013). Currently not an issue with PFLT.
Even with PFLT’s recommendation and risk/performance upgrade, this stock currently does not present “good” value. As such, I/we currently deem PFLT is not attractively valued. Therefore, subscribers should not currently initiate or add to one’s existing position. In my opinion, a modest - notable pullback in PFLT’s stock price would first need to occur. If/When PFLT can generate NII at or above $0.35 per share, this BDC will receive another upgrade.
2) MFIC:
Commentary
Quarterly NAV Fluctuation: Basically an Exact Match (0.1% Variance).
NII: Basically an Exact Match ($0.003 Per Share Variance).
An “as expected” quarter regarding MidCap Financial Investment’s MFIC 0.00%↑ NAV in my opinion. MFIC reported a relatively unchanged NAV fluctuation which matched my expectations. As such, MFIC’s underlying portfolio company valuations (both realized and unrealized) matched my expectations. MFIC reported a combined net realized loss and unrealized appreciation of $3 million during Q1 2024. In comparison, I projected a combined net realized loss and unrealized appreciation of $5 million. There were no “notable” surprises regarding quarterly FMV fluctuations within MFIC’s 154 portfolio companies during Q1 2024.
Also, an “as expected” quarter regarding MFIC’s NII in my opinion. MFIC reported a minor quarterly NII decrease which matched my expectations. Still, let us briefly discuss MFIC’s quarterly NII performance.
First, when excluding FMV fluctuations, MFIC increased the company’s investment portfolio size by $16 million during Q1 2024. This was due to $129 million of quarterly loan originations which “trumped” ($113) million in prepayments/repayments/exits. In comparison, I projected MFIC would increase the company’s investment portfolio size by a mean of $25 million. As such, a fractionally smaller investment portfolio size.
Second, MFIC reported a weighted average annualized yield of 12.10% and 12.00% during Q4 2023 and Q1 2024, respectively (0.10% decrease). This past quarter, this matched my expectations. As stated 2 quarters ago, I continue to believe this metric began to plateau towards the end of 2023. I continue to project a gradual decrease over time which is already factored in my/our modeling and percentage recommendation ranges. In addition, it should be noted the higher LIBOR/SOFR/PRIME rose (over 500 basis points [bps] in 1.5 years), the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2024.
So, I believe MFIC reported an “average” quarter (not great, not horrible). Basically flat NAV and a minor decrease in NII which largely matched sector averages. A risk/performance rating of 4 for MFIC remains appropriate in the current environment/over the foreseeable future.