Apollo Investment Corporation: Can You Count on This 11.5% Yield?
A High-Yield Stock Most People Have Never Heard Of
If you’ve been following dividend stocks long enough, you’d know that the highest yielders are usually not the safest bets.
Time after time, people put their hard-earned money into the highest-yielding ticker they see, only to find out that the company had to cut its payout later on.
If you are a long-term income investor, that’s not a situation you want to be in.
That’s why when Apollo Investment Corporation (NASDAQ:AINV), a company that yields north of 10%, popped up on my radar, I had to ask the question: is the payout safe?
Well, to answer that question, we need to first understand how the company makes money.
Apollo Investment Corporation
Headquartered in New York City, Apollo Investment Corporation is a closed-end investment management company with an objective of generating current income and capital appreciation.
Its main business is to provide private middle-market companies in the U.S. with customized financing solutions. Because these companies can’t always get loans from banks, they are willing to pay higher interest rates to get financing. And this has created an opportunity for lenders like AINV.
As of December 31, 2018, the weighted average yield of Apollo Investment Corporation’s total debt portfolio was 10.7%. (Source: “Third Quarter Fiscal Year 2019 Earnings Three Months Ended December 31, 2018,” Apollo Investment Corporation, February 6, 2019.)
Of course, just like the case with high-yield stocks, high-yield debt doesn’t really scream “safety.” But here’s the thing: the company has a strong focus on senior secured lending.
Approximately 64% of Apollo Investment’s portfolio was made up of first-lien debt at the end of 2018, and another 24% of the portfolio consisted of second-lien debt. (Source: Ibid.)
When you are a lender of first lien, you’ll be the first one in line to get paid if the borrower defaults and goes through liquidation.
Other than investing in senior secured loans, Apollo Investment also manages its risk through diversifying. It currently has investments in 103 companies coming from more than 10 different industries. Its three largest industry exposures—Aviation and Consumer Transport, Business Services, and Healthcare & Pharmaceuticals—represent 19.7%, 14.5%, and 13.3% of the company’s portfolio fair value, respectively. (Source: Ibid.)
So here’s what we know so far: by focusing on the underserved middle-market businesses, the company earns oversized interest income; and by having a diversified portfolio of senior secured loans, Apollo Investment makes sure that even if one company or industry enters a downturn, the impact on its total interest income stream will likely be limited.
The best part is, Apollo Investment Corporation is structured as a business development company (BDC). This means that it is required by law to return at least 90% of its profits to investors in the form of dividends.
The company currently pays quarterly dividends of $0.45 per share, giving AINV stock a jaw-dropping annual yield of 11.5%.
Covering the Payout
Like most BDCs, Apollo Investment Corporation reports a performance metric called net investment income. By comparing this figure to its dividend, investors can see whether the company earned enough money to cover its payout in a given reporting period.
According to the latest earnings report, Apollo Investment Corporation generated a net investment income of $0.45 per share in the quarter ended December 31, 2018. (Source: “Apollo Investment Corporation Reports Financial Results for the Quarter Ended December 31, 2018,” Apollo Investment Corporation, February 6, 2019.)
During the reporting quarter, the company declared a dividend of $0.45 per share.
In other words, Apollo Investment earned enough profit to cover the payout, but it did not leave any margin for error.
Now, before we come to a conclusion, there are two more things I want to point out about this high-yield stock.
Floating Rate Portfolio
First, 100% of the company’s debt investments bear interest at floating rates. So if interest rates go up—a trend that has been happening for a while—Apollo Investment Corporation could earn higher interest income from those investments.
Of course, the company also has interest-bearing liabilities, but the potential rise in interest income will likely outweigh the increase in interest expense if rates do go up. In particular, management estimated that if the benchmark interest rates increase by 100 basis points, the company would generate an additional $6.7 million in annual net investment income.
Trading at a Discount
Another thing to note is that at the end of December 2018, Apollo Investment Corporation had a net asset value of $19.03 per share. And yet, at the time of writing, the stock was trading at $15.59 apiece.
This means that if the company’s fundamentals haven’t changed much in the last two months, its share price would represent an 18%-plus discount compared to its net asset value.
The Bottom Line on Apollo Investment Corporation
At the end of the day, I’m a risk-averse income investor, so I’d like to see a wider margin of safety in the company’s dividend coverage ratio. But as it stands, Apollo Investment Corporation does have a solid business model in place, and its floating rate strategy and discount to net asset value could add more appeal. For investors who understand the underlying risks with ultra-high yielders, AINV stock’s 11.5% payout could be worth a look.