SLR Funding: Continued NII Development Anticipated From Q1 Earnings (NASDAQ:SLRC)

Overview

When investing into enterprise growth corporations, I are likely to give attention to how sustainable the excessive yield is. In spite of everything, the excessive yield is the primary attraction as I take advantage of BDCs to prioritize and add earnings to my portfolio. I got here throughout SLR Funding Corp (NASDAQ:SLRC) this previous weekend and wished to see if it met my requirements. For me to contemplate a BDC, they’ve to satisfy the next standards:

Various portfolio of investments throughout totally different sectors. Robust portfolio credit score high quality. Web Funding Revenue should out earn the distribution by a ample margin on a constant foundation. Rising Web Asset Worth. Clear reporting on the great and unhealthy.

With this stuff in thoughts, let’s additionally check out SLRC’s whole return efficiency in comparison in opposition to some friends. We are able to see that SLRC has the worst whole return profile in contrast in opposition to these batch of peer BDCs, together with PennantPark Floating Charge Capital (PFLT), Foremost Avenue Capital (MAIN), Fidus Funding Corp (FDUS), and Prospect Capital (PSEC). I discover it very odd that Prospect Capital has had the worst value efficiency out of those batch of friends however nonetheless manages to outperform SLRC. This was the very first thing to lift a purple flag in my thoughts however lets look a bit deeper and provides SLRC a good probability earlier than coming to any presumptions.

For context, SLRC operates as a enterprise growth firm that focuses on investing in corporations which have an EBITDA between the vary of $15M to $100M, making this a center market centered BDC. What makes SLRC a bit totally different is that it is technically categorised as a closed finish fund that’s externally managed however they elected to be categorised as a BDC.

Portfolio & Technique

SLRC’s technique is to spend money on senior secured loans of those center market corporations. Their major goal is to generate earnings from these investments, to be disbursed out to shareholders. They do that by investing in 4 totally different senior secured funding varieties: Money stream loans, Asset-based loans, Tools financing, and Life Science loans. Having a look at their newest portfolio composition, we will see that tools financing makes up the biggest bulk of their portfolio. Asset based mostly loans make up the second largest bulk at 31.6% of the portfolio and has the best weighted common yield of 14.5%.

As well as, the portfolio has publicity to over 110 totally different industries and holds about 790 distinctive issuers. This provides the whole portfolio a median publicity of solely 0.1% per issuer, or $3.9M. So SLRC will get a examine for portfolio range! As well as, the portfolio is made up of principally floating fee loans, sitting at roughly 65.3% as of final quarter. This has helped SLRC profit from the quickly rising rate of interest atmosphere beginning in 2022. We are able to see how the worth of SLRC rose when charges had been reduce to close zero ranges.

Conversely, the worth of SLRC decreased after which stabilized as soon as charges rose beginning in 2022. Whereas this will likely have slowed value development, the NII (internet funding earnings) rose due to their portfolio of floating charges that had been in a position to successfully pull in larger ranges of curiosity earnings from their investments.

Lastly, over 97% of their portfolio sits in first lien senior secured loans which is nice from a danger administration perspective. Senior secured loans sits on the highest of the company capital construction which implies that they’re essentially the most prioritized by way of compensation. In circumstances the place portfolio corporations are going by default or liquidation, which means that SLRC’s money owed are available on the prime of the record for compensation, providing some further safety.

Financials – Earnings Estimate

SLRC is about to reported their Q1 earnings on Could eighth after market shut. their final This autumn earnings reported in February, I wished to supply some earnings estimates as I consider it is going to be one other robust quarter for SLRC. NII was reported in at $0.44 per share whereas whole funding earnings rose 0.3% 12 months over 12 months. NII elevated 7.3% from the prior 12 months as effectively resulting from elevated charges.

As I beforehand talked about, the next rate of interest atmosphere has led to extend in SLRC’s internet funding earnings. Charges began rising round Q2 of 2022 and we will see that take impact on SLRC’s earnings of their historical past under. During the last Fed assembly, it was confirmed that charges will stay on the 20 years excessive for an extended time period resulting from excessive inflation and a powerful job market. This might be a perfect time to be in a BDC that’s principally comprised of floating fee loans to finest capitalize on this atmosphere.

With the extended interval of upper charges in thoughts, I absolutely anticipate SLRC to proceed pulling in the next NII above $0.42 at minimal. I estimate that their Q1 earnings to be reported quickly, will present NII between a spread of $0.43 – $0.45 per share due to the best degree of mortgage originations ever recorded by SLRC.

Originations for 2023 reached their highest degree ever, serving to contribute to a barely rising NAV as much as $18.09 per share. Throughout This autumn, the corporate made about $450M in funding in the course of the quarter to proceed rising their portfolio on this favorable atmosphere. Because of the heightened degree of investments over the past 12 months, I absolutely anticipate their 2024 steering to be larger.

That is reassuring to see administration capitalize on the upper fee atmosphere and proceed to develop their portfolio. Moreover, the corporate’s present internet debt to fairness ratio sits at 1.19x, falling inside the firm’s focused vary of 0.9x – 1.25x. SLRC’s liquidity profile is stable with $613M drawn on a complete of $860M of commitments.

Dividend & Valuation

Primarily based on the most recent declared quarterly dividend of $0.41 per share, the present dividend yield is 10.6%. As beforehand talked about, NII for the quarter was reported in at $0.44 per share. This might signify a dividend protection of roughly 107%, which in my view isn’t vast sufficient of a margin to instill confidence of long run protection. Consequently, we have seen an enormous lack of dividend raises or supplementals, which is odd contemplating the favorable atmosphere right here.

Whereas there’s nothing inherently fallacious with not rising the distribution or rewarding shareholders with supplementals, this admittedly does make SLRC a bit much less interesting as an earnings centered funding once you examine it in opposition to different peer BDCs which have offered this stuff. Utilizing Portfolio Visualizer, we will see how the earnings development of SLRC would in contrast in opposition to peer BDCs, Hercules Capital (HTGC) and PennantPark Floating Charge Capital (PFLT).

This comparability assumes a $10,000 preliminary funding in 2012 with no further capital ever being deployed. Nonetheless, dividends had been reinvested throughout this time. We are able to see that in 2012, SLRC’s dividend earnings was larger than these friends, amounting to an annual quantity of $1,131, in comparison with HTGC’s $1,040 and PFLT’s $956. Quick ahead to 2023 and we will see that SLRC’s dividend earnings will get smoked by these friends.

2023’s Whole Dividend Revenue

SLRC: $2,111 PFLT: $3,340 HTC: $6,169

Remaining Place Steadiness – 2024

SLRC: $21,540 PFLT: $34,497 HTGC: $68,723

Whereas all of those BDCs providing comparable dividend yield profiles, we will see that HTGC and PFLT has higher capitalized and rewarded shareholders with the next degree of dividend earnings and higher whole return. These totals account for all raises and supplementals that had been distributed. You may argue “why would I care about dividend development if the yield is already excessive?” however on the similar token, why would you accept much less dividend earnings in an atmosphere that is alleged to be extraordinarily favorable for SLRC? On account of this information, SLRC wouldn’t meet my private standards for consideration as a part of my portfolio.

When it comes to valuation, SLRC has constantly traded at a reduction to NAV (internet asset worth) during the last decade. For the time being, the worth trades at a reduction to NAV that’s better than it was earlier than the pandemic in 2020. The present low cost sits at -14.7%. For reference, the worth traded at a median low cost to NAV of -15.09% during the last 3 12 months interval.

Regardless that the present low cost to NAV sits larger than the three 12 months common, I consider this could be a great entry level for those who wished to carry SLRC. As beforehand talked about, it doesn’t look like fee cuts are within the close to future based mostly on the most recent Fed assembly. Which means that situations will seemingly proceed to be extra favorable for SLRC and they need to proceed to drag in larger internet funding earnings.

On account of this, I can see the low cost finally shrinking as NAV grows and the worth appreciates. As a reference, earlier than the preliminary drop brought on by the pandemic, the worth vary f SLRC sat between $18 – $20 per share. Since market situations have remained favorable, SLRC’s new investments might contribute to future development to get the worth again to these ranges.

Danger Profile

When it comes to transparency of report, SLRC additionally will get a examine right here in my view as they offered a transparent score system of their investments. The corporate has a numbered score system for the credit score high quality of their portfolio corporations, from 1 – 4. A score of 1 is the very best quality, assuming that the portfolio firm is exceeding expectations and paying off their debt with zero points. A score of 4 is the worst, seemingly that means that the portfolio firm is considerably underperforming and full compensation is now not anticipated.

We are able to see that almost all of their portfolio sits at a score of 1 and a couple of, for an approximate whole of 97%. That is reassuring from a high quality standpoint in addition to the corporate’s low non-accrual fee. Non-accruals are portfolio corporations that aren’t in a position to pay their money owed and are now not contributing to SLRC’s internet funding earnings. As of their final earnings name, we acquired the next affirmation.

We proceed to be happy with the credit score high quality of our portfolio with no new non-accruals in the course of the quarter. Our December 31 non-accrual fee base cease [ph] was 0.6% and 0.4% on truthful worth, which remained considerably under the BDC business common. – Michael Gross, Chairman and Co-CEO

For reference, listed here are a number of the non-accrual charges for the friends beforehand talked about:

PFLT: 0.1% of funding value. HTGC: 1.2% of funding value. PSEC: 0.2%

Takeaway

Whereas SLR Funding Corp (SLRC) has a rising NII by making the most of the engaging fee atmosphere, the shortage of supplementals and dividend raises stand out to me. They seemingly aren’t in a position to present many will increase as a result of the NII covers the distribution by a slight margin of solely 107%. I additionally anticipate the portfolio to proceed rising contemplating the give attention to new investments inside which can seemingly contribute to larger NII ranges as charges stay elevated. Whereas the portfolio high quality can be various and non-accruals stay low, I in the end is not going to be beginning a place in SLRC as there are extra engaging friends that I’m already uncovered to in my portfolio. With that being stated, in case you are already a very long time holder, I do not see any purple flags that might make me counsel a promote. Subsequently, I’d fee SLRC as a Maintain for now.