Monthly Dividend Stock In Focus: PennantPark Floating Rate Capital - Sure Dividend

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Monthly Dividend Stock In Focus: PennantPark Floating Rate Capital


Updated on September 13th, 2022 by Josh Arnold

At first glance, PennantPark Floating Rate Capital (PFLT) has great appeal to income investors. That’s because PennantPark has a staggering 9.4% dividend yield. In addition, unlike many of its competitors, the company has managed to pay the same dividend per share for seven consecutive years.

PennantPark is one of over 100 stocks in our coverage universe with a 5%+ dividend yield. You can see the entire list of 5%+ yielding stocks by clicking here.

Not only that, but PennantPark also pays its dividend each month. This allows investors to compound their wealth even more quickly than a stock that pays a quarterly or semi-annual dividend.

There are currently 49 monthly dividend stocks. You can download our full Excel spreadsheet of all monthly dividend stocks (along with metrics that matter like dividend yield and payout ratio) by clicking on the link below:

 

But, as is so often the case with sky-high dividend yields, PennantPark’s attractive dividend yield may be too good to be true.

This article will discuss the company’s business model, and whether or not the payout is sustainable over the long term.

Business Overview

PennantPark is a Business Development Company, or BDC. It provides mostly debt financing, typically first-lien secured debt, senior notes, second lien debt, mezzanine loans, or private high-yield debt. It specializes in making debt investments to middle-market companies. To a lesser extent, it also makes preferred and common equity investments. The most recent balance sheet showed about 87% of the company’s total investments were in first-lien senior secured debt.

The company’s portfolio is highly diversified, with no particular industry making up more than 8% of the total mix, and the vast majority comprising less than 3% of the total.

Source: Investor Presentation

In addition, the company’s portfolio is entirely floating rate, which opens up its yields to interest rate volatility. This can be good in times of rising rates, but is unfavorable should rates decline.

An overview of the company’s investment philosophy reveals PennantPark prefers middle-market companies with $15 million to $50 million in annual EBITDA and has a high rate of underwriting success.

Only 13 of the company’s 391 investments since inception have reached the non-accrual stage. This track record of outstanding underwriting is a key advantage for PennantPark, and it is this outstanding credit quality that has helped the company maintain its dividend at the same rate for several years.

Source: Investor Presentation

Above is a sampling of the types of investments the company makes in target companies. Not only are the targets themselves from diverse industries and geographies, but PennantPark has a variety of instruments with which to make its investments.

First-lien secured debt is the preferred instrument given its favorable repayment position, but the company will do revolvers and equity injections as well. This is primarily a floating debt investment firm, however.

Growth Prospects

PennantPark has demonstrated a track record of successful investments. However, its exposure to floating rate instruments has caused its average portfolio yield to fall over the past several years. The yield on PennantPark’s portfolio peaked at just over 9% at the end of 2018, but the company faced declines in the subsequent years. However, the average portfolio yield is back to 9.3% following the sizable increases in rates we’ve seen in 2022.

As PennantPark’s portfolio is entirely comprised of floating rate instruments – mostly tied to LIBOR – it benefits when interest rates are increasing. Low rates over the past decade suppressed the company’s investment income, but the potential for higher rates is a future catalyst. To an extent, that has come true in 2022 with rising rates.

PennantPark reported third-quarter earnings for the fiscal year 2022 on August 3rd, 2022. The company’s fiscal year ends at the end of September. The company reported total investment income of $25.7 million, up from $20.9 million in the year-ago period. Adjusted net asset value per share ended the quarter at $12.02.

Investments were $105 million for the quarter, comprised of six new companies and 39 existing portfolio companies. The weighted average yield on debt investments came to 8.1%. Sales and repayments of investments was $55 million, so the company added a net $50 million to the balance sheet. Cash and equivalents ended the quarter at $41 million.

Net investment income was 29 cents per share, up from 27 cents in the year-ago period. The portfolio ended the quarter at $1.23 billion, comprised of $1.06 billion in first-lien secured debt, and $163 million in preferred and common equity.

While we believe PennantPark has the track record and financial means to continue growing in the coming years, we have concerns over its ability to maintain its dividend. We forecast just 1.3% average growth in the coming years on an earnings basis, from our 2022 base of $1.20 per share.

Dividend Analysis

PennantPark pays a monthly distribution of $0.095 per share. The stock has a very attractive annualized dividend yield of 9.4%. Even better, it makes monthly dividend payments, so investors receive their dividends more frequently than they would on a quarterly schedule.

Related: The 10 Highest Yielding Monthly Dividend Payers

However, it is also important to assess whether the dividend is sustainable. Abnormally high dividend yields could be an indication that the dividend is in danger. We would expect a BDC to have a high yield, but the 9.4% yield is high even by BDC standards.

PennantPark Floating Rate also has a highly leveraged balance sheet and a payout ratio that often nears or exceeds 100% of earnings. While the company can probably sustain this model while the economy is running smoothly as the stable dividend over the past decade has shown it may collapse if the economy experiences a significant and prolonged downturn that would cause its loans to underperform.

Still, shareholders should certainly not expect a distribution increase in the near term given how close the payout is to earnings today. PennantPark’s ability to grow the portfolio and its average yields, while keeping expenses under control, will determine if the distribution is sustainable.

The company currently earns more in NII than it pays out in distributions. Thus, we aren’t expecting a dividend cut, but add that if credit quality deteriorates, or if rates move down, PennantPark’s earnings will suffer and a dividend cut may become a reality. We note this hasn’t happened yet, but risks have risen for PennantPark given the way its portfolio is constructed with floating-rate instruments. Rates are still rising today, so we don’t see the dividend as at risk today. However, it’s something investors should monitor continuously.

Final Thoughts

The old saying “high-risk, high-reward” seems to apply to PennantPark. It certainly has an attractive dividend yield on paper, but there potentially could be dividend concerns down the road if interest rates move lower.

If everything goes according to plan, the stock could generate nearly double-digit total returns on an annual basis from the yield alone.

There is an elevated level of risk for the company. If PennantPark does not grow investment income, it could be forced to reduce the dividend at some point in the future, but we do not currently forecast that.

Still, investors should tread carefully, and only those with a higher risk tolerance should consider buying PennantPark despite the very high yield.

If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:

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