Apollo Investment Corp.: A 10.5% Yield You Likely Haven’t Considered
Little-Known Stock Provides a Big Payout
Today’s chart highlights one of the most generous dividend-paying companies in the current stock market: Apollo Investment Corp. (NASDAQ:AINV).
To most people, Apollo Investment Corp. isn’t a familiar name. That’s because the company doesn’t offer products or services to consumers directly. Instead, it is a closed-end investment management firm founded in 2004.
In my opinion, the best way to look at Apollo Investment Corp. is to think of it as an alternative bank. This bank does not have any branches, because it lends to a very specific group of borrowers: middle-market businesses in the United States.
You see, in the past, when middle-market companies needed money to fund a growth project, they could just go to a bank and get a loan. But, due to tightening regulations in the financial services industry, today’s banks don’t usually lend to the middle market. As a result, middle-market businesses have to pay higher interest rates to obtain financing.
And that has created an opportunity for middle-market lenders like Apollo Investment Corp. As of March 31, 2018, the company’s total debt portfolio had a weighted average yield of 10.7%. (Source: “Apollo Investment Corporation Reports Financial Results for the Quarter and Fiscal Year Ended March 31, 2018, Announces Executive Officer Appointments, and Announces Changes to Fee Structure,” Apollo Investment Corp., May 18, 2018.)
Apollo Investment Corp. Offers Oversized Dividends
Here’s the neat part: Apollo Investment Corp. chooses to be regulated as a business development company (BDC). This means it is required by law to distribute at least 90% of its taxable income to shareholders in the form of dividends.
In return, BDCs pay little to no federal income tax at the corporate level.
Thanks to this passthrough structure, a substantial portion of Apollo Investment Corp.’s oversized interest income gets passed directly to shareholders.
Right now, the company pays quarterly dividends of $0.15 per share. Trading at around $5.70 apiece, AINV stock offers a staggering annual yield of 10.5%.
Of course, investing in high-yield debt doesn’t seem like the safest business. The good news is, Apollo Investment has put in a lot of effort managing its risk.
First, while the company invests in high-yield debt, it focuses primarily on senior secured loans. In fact, about 50% of its total portfolio is invested in first lien debt, and another 32% of the portfolio is invested in second lien debt. (Source: “Apollo Investment Corporation Investor Presentation,” Apollo Investment Corp., last accessed May 24, 2018.)
When you are a first lien lender, you will be first in line to get paid if the borrower defaults and goes through liquidation.
Moreover, the company’s portfolio is well-diversified. Apollo Investment currently has 86 portfolio companies coming from 24 different industries. Its average borrower exposure is less than 1.2% of its total net assets.
Therefore, if one of the portfolio companies struggles to come up with a payment, the impact on Apollo Investment’s company-level financials will likely be limited.
And if you are wondering how the company will do in today’s rising interest rate environment, note that, over the last few years, Apollo Investment has significantly increased its exposure to floating rate debt.
Investment Portfolio Exposure to Floating Rate Debt
(Data source: Ibid.)
You see, by the end of June 2016, approximately 77% of the company’s debt portfolio bore interest at floating rates. By the end of March 2018, Apollo Investment had increased its debt portfolio’s floating rate exposure to 92%, leaving just eight percent of its loans bearing interest at fixed rates.
Interest rates have been increasing. The U.S. Federal Reserve is projecting a total of three rate hikes for this year. In a rising interest rate environment, Apollo Investment’s large floating rate exposure will likely translate to higher interest income.
And the company doesn’t need that to happen in order to meet its current dividend obligation. In the fiscal year ended March 31, 2018, Apollo Investment Corp. generated net investment income of $0.61 per share, while its dividends totaled $0.60 per share for the year.
At the end of the day, I wouldn’t call Apollo Investment a slam dunk. As a risk-averse income investor, I’d like to see a higher margin of safety in the company’s dividend coverage.
But in an era when the average S&P 500 company pays less than two percent, AINV stock’s double-digit yield could be an opportunity.