Undervalued, 11%-Yielding PennantPark Stock’s Payout Raised for 7 Straight Quarters
August 17, 2023
Why Investors Should Consider PNNT Stock
It continues to be a wonderful time to look at interest-rate-sensitive stocks, such as those of business development companies (BDCs) like PennantPark Investment Corp. (NYSE:PNNT).
Why?
If you want to be a cigar-puffing, champagne-swilling Wall Street private equity investor but don’t have millions of dollars to drop into middle-market companies, you might want to consider shares of BDCs. These firms lend capital to small and medium-sized private companies that need cash to expand their businesses.
Because of their deep pockets, each BDC invests in dozens to hundreds of private companies—and there are a lot of private businesses looking for cash infusions. From 2002 to 2021, the total assets of public BDCs ballooned from $5.0 to $200.0 billion.
How does that help income investors?
Most BDCs use floating interest rates for the debt in their portfolios. In the current interest-rate-sensitive environment, this has helped juice their bottom lines. And because astute BDCs are good at finding excellent companies to invest in, they have a low default rate, just 1.6%. (Source: “Proskauer’s Q2 2023 Private Credit Default Index Reveals Default Rate of 1.64%,” Proskauer Rose LLP, July 19, 2023.)
Like real estate investment trusts (REITs), BDCs legally have to pay out at least 90% of their taxable income to investors as dividends. The yields can be quite high, averaging 10.7%. That’s far superior to S&P 500 stocks, which have an average yield of just 1.5%, master limited partnership (MLP) stocks’ average yield of 7.8%, and junk bonds’ average yield of 8.3%.
PennantPark is a private equity fund that focuses on U.S. companies owned by middle-market private equity sponsors with a track record of supporting their portfolio companies. (Source: “Investor Presentation,” PennantPark Investment Corp., December 31, 2022.)
Why middle-market companies? The U.S. middle market includes nearly 200,000 companies, annually generates $10.0 trillion of revenue (1/3 of the U.S. economy), and is the world’s fifth-largest economy on a standalone basis.
PennantPark Investment Corp. invests between $10.0 and $100.0 million in companies with $10.0 to $50.0 million worth of earnings before interest, taxes, depreciation, and amortization (EBITDA). The BDC invests in the form of senior secured loans, subordinated debt, mezzanine debt, and equity investments.
Not all forms of debt are created equal, so it’s important to know what the different types of loans are and how they’ll affect PennantPark if a borrower defaults on its loan. For instance, a BDC with a lot of senior debt stands first in line to get its money back. Mezzanine lenders get paid second. Meanwhile, preferred and equity lenders usually receive only a fraction of their original investments back (if anything at all) in the event of bankruptcy.
As of June 30, PennantPark Investment Corp.’s $1.1-billion portfolio consisted of $590.5 million of first-lien secured debt, $94.8 million of second-lien secured debt, $154.7 million of subordinated debt, and $235.8 million of preferred and common equity debt. Its debt portfolio consisted of 96% variable-rate investments and four percent fixed-rate investments.
The BDC’s portfolio currently includes 125 companies with an average investment of $9.6 million at 11.9% yield at cost on debt.
Industries targeted by PennantPark include aerospace and defense; buildings and real estate; business services; chemicals, plastics, and rubber; consumer products; electronics; energy and utilities; financial services; gaming and leisure; health care, education, and childcare; hotels; insurance; media; and telecommunications.
PennantPark Investment Corp. Reported Q3 Earnings & Revenue Beat
For the third quarter of fiscal 2023 (ended June 30), PennantPark announced revenues (investment income) of $45.0 million, up by 92.7% from $23.3 million in the same quarter of fiscal 2022. (Source: “PennantPark Investment Corporation Announces 5.0% Increase of Its Quarterly Distribution to $0.21 per Share and Financial Results for the Quarter Ended June 30, 2023,” PennantPark Investment Corp., August 9, 2023.)
Management also reported fiscal third-quarter net investment income of $23.0 million, or $0.35 per share. This was up from $0.16 per share in the same quarter a year ago and topped Wall Street analysts’ projections of $0.29 per share.
During the fiscal 2023 third quarter, PennantPark Investment Corp. invested $69.9 million in three new and 43 existing portfolio companies at a weighted average yield on debt investments of 12.6%. In the third quarter of 2022, it invested $326.3 million in 11 new and 36 existing portfolio companies at a weighted average yield on debt investments of 8.7%.
In the nine months ended June 30, 2023, its investment income rallied by 46% year-over-year to $111.3 million. In the same period of 2022, the BDC’s net investment income went up by 40.8% to $49.0 million, or $0.77 per share.
Also in the nine months ended June 30, 2023, PennantPark Investment Corp. invested $214.4 million in 15 new and 60 existing portfolio companies at a weighted average yield on debt investments of 11.9%. In the nine months ended June 30, 2022, it invested $799.4 million in 35 new and 48 existing portfolio companies at a weighted average yield on debt investments of 8.2%.
Management Raised Quarterly Dividend 40% Year-Over-Year
PennantPark’s high cash generation has resulted in a number of increases to PNNT stock’s quarterly distribution: seven so far. (Source: “Dividends and Distributions,” PennantPark Investment Corp., last accessed August 16, 2023.)
Most recently, on August 9, the company declared a quarterly distribution of $0.21 per share, for a yield of 11%. That’s more than triple the current inflation rate of about 3.1%. The $0.21 payout represents a five-percent increase over the second-quarter dividend of $0.20 and a 40% increase over the 2022 third-quarter dividend of $0.15.
For now, the company’s quarterly dividend is well covered by its net investment income.
Beginning in October, PennantPark Investment Corp. is switching the frequency of its distributions from quarterly to monthly. Frankly, most shareholders would rather get paid monthly than quarterly.
PennantPark Stock’s Price at Record-High Level But Still Undervalued
Strong financial results have been helping send PNNT stock’s price higher. In fact, on August 19, PennantPark stock hit a new all-time record high of $7.07, for a year-to-date gain of 29.7%.
PNNT stock has retraced a little from that record level, but—as of this writing—it’s still trading up by:
- 5.6% over the last month
- 27% over the last three months
- 24% year-to-date
- 13% year-over-year
Those are solid gains, and Wall Street analysts see PennantPark stock climbing even higher over the coming quarters. Analysts have provided a 12-month median share-price estimate of $7.00 and a high estimate of $8.00 per share. This points to potential gains in the range of 5.6% to 21%.
Chart courtesy of StockCharts.com
The Lowdown on PennantPark Investment Corp.
PennantPark is a terrific BDC that’s good at making lots of money and providing its shareholders with ultra-high-yield dividends.
Recently, PennantPark Investment Corp. reported a third-quarter earnings and revenue beat, raised its quarterly dividend, and saw its share price hit a record high.
Moreover, the company’s earnings stream is robust, which should help it continue rewarding buy-and-hold investors with frothy dividends.
