BlackRock Capital: Average BDC with a dividend yield of 9.83% (NASDAQ: BKCC)

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Investment thesis

BlackRock Capital Investment Corporation (NASDAQ: BKCC) management is moving toward its goal of securing the company’s portfolio. This portfolio restructuring may lower the company’s default loan rate from above average. The there are still a number of investment companies in this grade 4 rating, but if there is no major recession when these mid-market companies fail, BKCC’s portfolio could be considered safe. The company also has a below-average yield on income-producing securities and trades just 13% below its net asset value. That’s why I’m still neutral on BKCC.

business model

BKCC is a business development company that invests in middle-market US companies through senior secured loans, subordinated loans and equity. BKCC is the 32nd largest BDC in the United States among the 49 publicly traded BDCs. The vast majority of the company’s debt is made up of senior secured senior loans and this share has increased quarter over quarter. Management made a commitment about a year and a half ago to restructure the portfolio and increase the share of senior loans. It was a success because since my last article they were able to increase the share of senior loans in the portfolio by 4.7%. Management’s long-term goal is a total senior loan portfolio of 80% with more than 100 portfolio companies. They also aim to reduce unsecured assets below 5% of the total portfolio. Management could also increase net investment income over the past 12 months.

BKCC Net investment income ttm

Investor Presentation May 2022

American middle market companies

According to Fitch Ratings, US corporate loan issuers will face greater risk in the second half of 2022 than before in a near-zero interest rate environment as interest rates begin to climb. BKCC typically has a higher default rate than middle market loan default rates of 1.4% on large middle market loans and 0.8% on institutional leveraged loans. The company (like all BDCs) has a rating for its debt. They view 4th grade as,

Investments in portfolio companies that perform significantly below the Advisor’s initial baseline scenario expectations or risk factors have increased significantly since the time of initial investment or subsequent restructuring. Some loss of principal (or invested capital) is expected.

As of 03/31/2022, the company had 4.4% of its assets in Grade 4 rating. This does not mean a default rate of 4.4%, but if only a third of these assets are in default, c is above the industry average. In addition, Fitch expects growth in middle market loan defaults in 2022 compared to 2021. However, the good news is that the general default rate of companies BKCC invests in is very similar to that of large American companies.

General default rate of middle market companies

moodysanalytics.com

Evaluation

BKCC is trading 13% below its net asset value. That’s a better deal than buying the company in December with a P/NAV of 0.99. However, the drop is justifiable, and it was not due to the price drop in 2022 as BKCC has a YTD yield of -0.1%. The decline in price to NAV was slightly due to the decline in NAV and total assets. BKCC’s total assets decreased by around 6.8% last quarter. BKCC’s yield on income-producing securities (at fair value) is 8.5%. This is below the industry average and median, but similar to Saratoga Investment Corp’s 8.5% percentage interest. (SAR) on his wallet. But comparing it to a similar market cap BDC such as Horizon Technology Finance (HRZN), it has a portfolio yield on debt investments of 12.4%. These factors suggest to me that the company’s current price is fairly priced against January’s price.

BDC returns

Saratoga Investment Investor Presentation

Company specific risks

The main risk for BKCC and its shareholders is rising default rates and more assets moving from grade 4 to grade 3. I think this is the biggest risk management faces for 2022 and 2023. If the worst-case scenario occurs and more portfolio companies default on their loans, BKCC will have to cut its dividend. It is also possible that interest charges will increase due to the general rise in interest rates, but if BKCC continues to lend at a variable rate, this could only cause a problem in the short term. I would have rated the restructuring of the portfolio as a major risk a year and a half ago, but it looks like management can show some positive results and are on track to complete the full restructuring of the portfolio towards safer assets .

My Updated View on the BKCC Dividend

There has been no change in BKCC’s dividend since 2021. The company still pays the same $0.1 per share quarterly and no analyst expects a dividend increase in 2022 or 2023. It has a forward dividend yield of 9.83%. The payout ratio is still well above the 100% barrier. BKCC has been able to maintain its dividends in part due to strong growth in the diluted weighted average number of shares outstanding over the past year. Management increased the average number of shares outstanding by 27.69% in 2021. I do not expect this to be sustained in future years. If NII growth cannot be sustained, the company may have to cut its dividend. If this growth stops, a small reduction in the dividend is possible in my opinion due to an excessively high payout ratio and the easing of new equity issues to support operations.

BKCC dividend payout ratio

The table is created by the author. All figures are taken from the company’s financial statements and SA earnings estimates.

Final Thoughts

BKCC isn’t any income investor’s dream company, but it does have some serious value beneath its surface. The main risk factor is the default rate and its grade 4 loans which can adversely affect the company’s NII. I believe the current price indicates a fair valuation due to the portfolio’s below average investment performance among other BDCs. Let’s see what happens when management completes portfolio restructuring. Until then, I’m neutral on BKCC.

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