NEUTRAL (FSC, $6.97)
Growth Challenges and High Leverage Temper our Expectations - Initiating With A Neutral Rating And $7 Price Target.
June 2, 2015
Christopher R. Testa
Investment Conclusion. We are initiating coverage of Fifth Street Finance Corp. (FSC) with a neutral rating and $7 price target. Fifth Street Finance Corporation is a middle market focused BDC investing mostly in senior secured debt with a smaller portion of the portfolio in subordinated debt, CLO debt, and equity. FSC has had further issues with asset quality the past two quarters. In fiscal 1Q15 non-accruals at fair value spiked to $59.9 million from $6.4 million in fiscal 4Q14. While non-accruals have declined to $51.0 million as of fiscal 2Q15 they are still significantly elevated. The stock is currently at a 24% discount to NAV and the company has stated that it will not even seek shareholder approval to sell shares below NAV and has no intentions of doing so. With a targeted regulatory debt-to-equity (D/E) ratio of 0.60x-0.80x and most recent quarter regulatory D/E of 0.75x the company is near its upper band of comfort leverage. Nonetheless Fifth Street has spare capacity in both of its credit facilities for a total of $412.7 million available to utilize including the accordion. The inability to issue equity has removed a major growth lever from FSC’s arsenal and while we do not anticipate net portfolio runoff given the debt capacity available we do estimate portfolio growth will slow markedly from what it has been the past several years. All-in effective yield has been under significant pressure, down 47 basis points (bps) quarter-over-quarter (Q/Q) and for fiscal 2014 was down 108 bps year-over-year (Y/Y). The company recently reduced its dividend to $0.18/share from $0.28/share since for 2Q15. Our $7 price target implies an estimated 2016 Price/Net Investment Income (P/NII) of 8.5x, dividend yield of 10.3%, and Price/Net Asset Value (P/NAV) of 0.74x compared to the BDC sector averages of 9.4x, 10.2%, and 0.95x, respectively.
Source: S&P Capital IQ, National Securities Corporation Estimates
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