New Mountain Finance Corp: This 10.2% Yield Is Worth a Look
A High-Yield Stock Worth Mentioning
For the most part, ultra-high yielders are known as risky bets. So when you see a stock with a yield north of 10%, it’s only natural to ask, “Is the payout safe?” Well, that’s what we are going to find out in this article.
The company in question is New Mountain Finance Corp. (NYSE:NMFC), a closed-end investment firm headquartered in New York City. To be more specific, it provides financing solutions to middle-market businesses in the U.S. These businesses typically have annual earnings before interest, tax, depreciation, and amortization (EBIDTA) of between $20.0 million and $200.0 million.
Generating tens of millions of dollars in EBITDA is already a solid achievement, but these companies are still not quite established enough. As a result, when they need money for growth projects or acquisitions, banks don’t always lend to them. And that’s where New Mountain Finance Corp finds its opportunity.
By focusing on middle-market lending, New Mountain Finance Corp. is essentially serving an underserved market. And because of the less established nature of middle-market businesses, these companies have to pay higher interest rates to obtain financing.
To middle-market lenders like NMFC, higher interest rates can translate to oversized profits. As of March 31, 2018, the yield at cost of the company’s portfolio stood at 10.6%. (Source: “Q1 2018 Earnings Presentation,” New Mountain Finance Corp., last accessed June 22, 2018.)
A True High-Yield Stock
Now, keep in mind that New Mountain Finance Corp. chooses to be regulated as a business development company (BDC). That means it must distribute at least 90% of its profits to shareholders in the form of dividends. In return, the company pays little to no federal income tax.
Thanks to this mandatory distribution requirement, New Mountain has become one of the most generous dividend payers in the current stock market. With a quarterly dividend rate of $0.34 per share, NMFC stock offers an annual yield of 10.2%.
Does the company make enough money to cover its payout? Well, in 2017, New Mountain Finance Corp. generated net investment income of $1.38 per share. The amount was more than enough to cover its total dividend payment of $1.36 per share for the year. (Source: “New Mountain Finance Corporation Announces Financial Results For The Quarter And Year Ended December 31, 2017,” New Mountain Finance Corp., February 28, 2018.)
In the first quarter of 2018, the company earned a net investment income of $0.34 per share, which was just enough to cover its quarterly dividend payment of $0.34 per share. (Source: “New Mountain Finance Corporation Announces Financial Results For The Quarter Ended March 31, 2018,” New Mountain Finance Corp., May 7, 2018.)
As a risk-averse income investor, I would like to see a higher dividend coverage ratio. But note that as it stands, the company already has some serious risk management measures in place.
Securing a Safe Income Stream
First of all, New Mountain Finance Corp. invests mainly in defensive growth companies. These companies tend to have recurring revenues, strong free cash flows, and sustainable growth drivers. It targets mostly acyclical industries such as education, healthcare services, and federal services.
Moreover, the company has a strong focus on senior secured lending. As of March 31, 2018, first-lien and second-lien debt accounted for approximately 77% of New Mountain’s total portfolio fair value.
The focus on senior secured lending is critical to a lender’s risk management. When a borrower goes bankrupt, senior debt has to be repaid before other creditors see a penny. And if you are a first-lien lender, you would be standing at the front of the line to get paid in the event of liquidation.
What’s more, due to the rising interest rate environment, New Mountain Finance Corp. has emphasized on making floating rate investments. Right now, floating rate loans represent 85% of the company’s total investments.
Meanwhile, more than half of New Mountain’s debt bear interest at fixed rates. Therefore, if interest rates go up (which they probably will), the increase in the company’s interest income would likely outweigh the increase in its interest expense. And that would translate to higher profits for the middle-market lender.
In the latest investor presentation, management estimated that if base interest rates go up by 100 basis points, New Mountain Finance Corp.’s interest income net of interest expense would increase by 7.8%. That would allow the company to earn an extra $0.11 per share in annual adjusted net investment income.
The Bottom Line on New Mountain Finance Corp.
At the end of the day, keep in mind that the company has to adhere to the mandatory distribution requirement for BDCs. Therefore, if it makes more profits as interest rates rise, it could also mail out bigger dividend checks.
And that’s why for income investors, NMFC stock’s 10.2% yield deserves a look.