Updated on March 7th, 2023 by Samuel Smith
At first glance, PennantPark Floating Rate Capital (PFLT) has great appeal to income investors. That’s because PennantPark has a staggering 10.8% 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 84 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.
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 majority comprising less than 3% of the total.
Source: Investor Presentation
In addition, the company’s portfolio is 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 16 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.
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 11.3% following the sizable increases in rates we’ve seen in 2022 and 2023 so far.
As PennantPark’s portfolio is 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 2022-2023 with rising rates.
Financial results for the first fiscal quarter ended December 31, 2022, were announced by PennantPark Floating Rate Capital Ltd. on February 8th, 2023. The Board of Directors declared a distribution of $0.10 per share, representing a 5.3% increase from the most recent distribution.
During the three months ended December 31, 2022, investment income amounted to $31.3 million, comprising $27.6 million from first lien secured debt and $3.7 million from other investments. By comparison, for the three months ended December 31, 2021, investment income was $26.3 million, which included $20.1 million from first lien secured debt and $6.2 million from other investments.
The primary reason for the rise in investment income from the same period in the prior year was the increase in the cost yield of the company’s debt portfolio.
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 0.1% average annualized growth in the coming years on an earnings basis, from our 2023 base of $1.24 per share.
PennantPark pays a monthly distribution of $0.10 per share. The stock has a very attractive annualized dividend yield of 10.8%. Even better, it makes monthly dividend payments, so investors receive their dividends more frequently than they would on a quarterly schedule.
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 10.8% 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.
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.
Don’t miss the resources below for more monthly dividend stock investing research.
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