by Dilok Klaisataporn
FS KKR Capital Corp. (NYSE:FSK) is buying and selling at a 26% low cost to ebook worth and presently pays a 12.9% dividend yield that’s coated by the corporate’s adjusted internet funding earnings.
Though the low cost to internet asset worth was greater in September than it’s now, I consider the big low cost displays a excessive margin of security for passive earnings traders, which might result in double-digit inventory returns for shareholders along with the 12.9% dividend yield.
Portfolio Composition
Compared to a few of its BDC friends, FS KKR doesn’t have the best publicity to First Lien Senior Secured Loans in its portfolio.
Enterprise growth corporations with greater First Lien percentages, corresponding to Blackstone Secured Lending (BXSL) or Oaktree Specialty Lending Company (OCSL), provide passive earnings traders greater total portfolio high quality, which interprets into decrease mortgage default dangers.
As of September 30, 2022, FS KKR had invested 61.9% of its capital in First Lien Senior Secured Loans, 7.9% in Second Lien Senior Secured Loans, and the rest in subordinated debt, asset backed finance, Credit score Alternatives Companions, and Most popular Fairness.
As of the top of the third quarter, FS KKR’s complete portfolio worth was $15.8 billion, with 195 portfolio corporations.
Portfolio Highlights (FS KKR Capital Corp)
Solely 49% of the BDC’s third-quarter investments went to the most secure debt kind, First Lien Senior Secured Loans, whereas 20% went to subordinated debt. This kind of debt presents greater yields to debt traders, but additionally greater funding threat as a result of some debtors might not repay the mortgage in full.
Some higher-quality BDCs have modified their portfolio compositions in favor of safer First Lien investments within the final yr, owing to considerations about an impending recession in 2023.
FS KKR doesn’t really feel the necessity to place its portfolio extra safely (lower than half of 3Q-22 investments have been made in First Liens), indicating that portfolio and dividend protection dangers are greater than common.
Asset Combine Of latest Purchases (KS KKR Capital Corp)
FS KKR, like most enterprise growth corporations, prioritizes investments in sectors which are much less cyclical and supply extra predictability when it comes to earnings and money movement.
FS KKR has a excessive publicity to the software program and providers, capital items, well being care, and insurance coverage sectors, which promise lenders much less money movement volatility and, because of this, a better likelihood of full mortgage reimbursement.
Sector Publicity (FS KKR Capital Corp)
Dividend Protection
FS KKR earned $2.77 per share in adjusted internet funding earnings during the last 4 quarters whereas paying out $2.66 per share, or $0.67 per share on common. In consequence, the dividend pay-out ratio during the last twelve months was 96.0%, indicating that FS KKR absolutely coated its dividend with adjusted NII.
Whereas there are different enterprise growth corporations with pay-out ratios lower than 96%, I consider FS KKR’s dividend is sustainable so long as the BDC’s debt portfolio high quality doesn’t deteriorate.
Monetary Outcomes (KS KKR Capital Corp)
26% Low cost To Guide Worth
For the previous yr, FS KKR Capital has been promoting at a reduction to internet asset worth, and the present low cost is just not even the biggest it has ever been. The BDC’s low cost to internet asset worth widened to 36% through the September selloff, however despite the fact that it has narrowed just lately, it’s nonetheless giant sufficient to offer passive earnings traders with a excessive margin of security, for my part.
Worth To Guide Worth (YCharts)
Why FS KKR May See A Increased NAV Low cost
There are two foremost the explanation why FS KKR’s valuation might fall sooner or later:
A U.S. recession might trigger capital suppliers to withdraw from debt investments. Moreover, a rise in mortgage defaults in a recessionary setting might lead to a rise in non-accruals and a deterioration of the BDC’s credit score high quality, inflicting traders to use bigger worry reductions to account for the potential for further mortgage losses.
My Conclusion
The 26% low cost on internet asset worth is a robust promoting level for FS KKR, despite the fact that the BDC is, all issues thought of, of common high quality.
The low cost to internet asset worth is giant sufficient to replicate an inexpensive margin of security, and if the hole between market value and internet asset worth closes, passive earnings traders might earn double-digit inventory returns on high of the 12.9% dividend yield.
The dividend was nonetheless coated by adjusted internet funding earnings as of September 30, 2022, and so long as the BDC’s portfolio high quality doesn’t deteriorate, I consider FS KKR can proceed to pay out dividends sooner or later.
