The market is clearly hot and bothered by the prospect of rising interest rates at some point in the not-too-distant future, suggests Bryan Perry, editor of Cash Machine.
Since perception is greater than reality, and fund flows dominate price action, we want to respect sector rotation and add to where the market is demonstrating relative strength.
Where high-yield investors can participate in a bullish manner is through owning shares in specific Business Development Companies (BDCs), where we continue to experience solid results during 2016.
BDCs are involved in helping grow small companies in the initial stages of their development. Like REITs, they are Regulated Investment Companies, which have to pay out 90% of net income to shareholders.
What makes BDCs uniquely different from REITs is that BDCs can use leverage to fatten up returns, employ the use of derivatives like equity warrants and management also can charge a performance fee.
The ideal BDC is focused on long-term value and making investments that will perform well over several years and can withstand different business cycles.
That same focus continues to be on companies and structures that are more defensive, have low leverage, strong covenants and high returns.
PennantPark Floating Rate Capital (PFLT) has a market cap of $345 million, net asset value of $13.75 and trades at an attractive discount of $12.90 per share.
There are 92 portfolio companies that have investments from PFLT, which has near-zero energy exposure, with the average loan interest charged at 8.0%.
Within the loan portfolio, 80% of the debt issued is backed by senior secured assets. As of June 30th, the company had one non-accrual on the books representing only 1.2% of the portfolio at cost.
Since the quarter’s end, that one investment is now back on accrual and paying interest. A tight ship takes a good crew. I had a very constructive call with Chief Financial Officer Aviv Efrat, and came away feeling quite bullish on PFLT’s prospects.
The current dividend yield – paid monthly -- is 8.82%. Earnings are forecast to rise by 15% in 2017 to $1.15 if rates don’t rise.
If interest rates move up by just 1.0%, earnings per share will spike by another 16 cents, which will translate to higher dividends and a higher stock price, making for a solid addition to the Conservative High Yield Portfolio.
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By Bryan Perry, Editor of Cash Machine
