NEUTRAL (TCRD, $12.35)
Muted NII/share Growth and Valuation Keeps us on Sidelines for Now - Initiating with a Neutral Rating and $14 Price Target.
April 27, 2015
Christopher R. Testa
Investment Conclusion. We are initiating coverage of THL Credit, Inc. (TCRD) with a NEUTRAL rating and $14 price target. We anticipate modest NII/share (net investment income per share) growth of 3.5% in 2015 and a slight decline of 1.4% in 2016. THL has excellent asset quality, a low cost of funds, and a portfolio that stretches across the entire capital stack. The company is a disciplined underwriter and one that we feel does not get enough credit for being willing to sit on dry powder, wait for appropriately priced opportunities, and execute on them. THL’s regional offices and direct origination platform provides for impressive points earned on loans and other fee income. The company has a near rock bottom effective cost of debt of 3.58% which has stepped down from 4.59% in 2013 and 6.45% in 2012. With the exception of subordinated debt, the investment performance at THL has been excellent. The company is currently sitting on slight unrealized gains and only has 0.8% of its portfolio is ranked 4 & 5, down from 5% in 4Q14. This is particularly impressive because the company’s portfolio is 50.2% first lien, 21.5% second lien, 12.8% subordinated, 2.6% fund investments, 6.7% equities, 1.7% in payment rights, and 4.5% in CLO residual interests. However, given where we think we are in the credit cycle we think that THL will shift into more first lien assets and will experience yield compression. The introduction of fixed rate notes should also increase the cost of funds by an estimated 52 bps in 1Q15 which should weigh on NIM. Thus despite sound asset quality and lack of dilutive issuance we anticipate net interest margin (NIM) will be under pressure and hinder NII/share growth. Thus we believe the valuation at the current price is close to the company’s intrinsic value. Our $14 price target implies an estimated 2016 Price/Net Investment Income (P/NII) of 9.7x, dividend yield of 9.7%, and Price/Net Asset Value (P/NAV) of 1.02x compared to the BDC sector averages of 9.2x, 10.1%, and 0.96x, respectively.
Source: S&P Capital IQ, National Securities Corporation Estimates
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