A couple of weeks ago, I wrote an article about PennantPark Floating Rate Capital (PFLT). Today, I’m focused on its close relative, PennantPark Investment (PNNT). While both PFLT and PNNT have underperformed the market, PNNT’s decline has been even more pronounced. As seen below, PNNT’s share price performance has lagged that of its peer by a 19% margin, for a nearly 50% share price decline since the start of the year.
(Source: Yahoo Finance)
In this article, I evaluate whether if PNNT presents an attractive investment opportunity or is something to be avoided, so let’s get started!
A Look Into PennantPark Investment
PennantPark Investment is an externally managed Business Development Company (BDC) that focuses on lending to companies in the middle-market space. Like its peer PFLT, it is also managed by PennantPark Investment Advisors, LLC. It was founded in 2007, and has deployed over $11 billion in capital since inception. Today, its loan portfolio is worth $1.3 billion and is spread across 86 different companies.
Compared to PFLT, PNNT has a risker loan portfolio, with a higher proportion of investments that are classified as second-lien secured debt and under. As seen below, just 59% of PNNT’s loan portfolio is first-lien secured debt and 77% of the portfolio is secured debt (first-lien plus second-lien). This is riskier compared to PFLT, which holds 90% of its loan portfolio as first-lien debt and 93% as secured debt. This puts PNNT at a disadvantage when faced with economic uncertainty, and is a key reason for why it has underperformed its peer so far this year.
(Source: July Investor Presentation)
Another risk factor for the company is the yield compression that has been taking place in recent years and which has been more pronounced since the start of the year. This resulted in tight dividend coverage in the recent quarters and led to the most recent dividend cut from $0.18 to $0.12 per share on a quarterly basis. I see the current dividend as being attractive, as it is well-covered by the $0.16 in NII that the company generated in the most recent quarter. This represents a high dividend yield of 14.5% on an annualized basis.
I see further downward pressure on interest rates as being mitigated by the Fed Chairman’s signaling that he’s unwilling to go into negative rate territory. In addition, further downside is protected by the fact that 86% of the portfolio has an average LIBOR floor of 1%. I’m also encouraged by the stabilizing Net Asset Value (NAV), which increased slightly by 1.4% over the last quarter. Looking at the portfolio mix below, it appears that PNNT’s loans are well-diversified, with the higher risk sectors of Hotels, Energy, and Automotive comprising just 10-15% of the portfolio.
(Source: July Investor Presentation)
I see this risk as already having been priced into the NAV, as evidenced by the 12% drop in NAV between last December to March of this year. Currently, only 1 out of 86 loans is on non-accrual status, representing just 2.3% of the portfolio at fair value. Going forward, I see more potential upside, especially within the energy sector, as oil prices have stabilized since hitting all-time lows in March. This is supported by management’s sentiment on the energy industry, as noted on the last conference call:
“Revenues and cash flow were materially reduced as the entire industry is conserving liquidity. While hedges in place were helpful, they only partially mitigate the impact of low oil prices. We are encouraged that with the partial reopening of the economy, oil prices seem to have stabilized around $40 and may trend higher in coming months.”
Meanwhile, the balance sheet is in good shape, with the regulatory debt-to-equity ratio being 1.49x, which sits well below the 2x debt-to-equity (or 150% asset coverage ratio) requirement for BDCs. In addition, management expects leverage to decrease by another $245 million through the formation of a joint venture senior loan fund with Pantheon, a global private markets investor.
Turning to valuation, I see shares as being attractively valued from a Price-to-NAV perspective. At the current price of $3.30, shares are trading at a Price-to-NAV of just 0.42. This compares favorably to the 0.74 Price-to-NAV ratio that the shares traded at end of 2019. I see upside for the shares with a narrowing of this discount and with the potential for further improvements to NAV through an easing of the pandemic and stabilization of energy prices. Wall Street analysts seem to share this sentiment, with an average price target of $4.00 per share, which sits comfortably above where shares are trading at today.
PennantPark Investment is a BDC with a diversified loan portfolio across many industries. While the current recession and yield compression have been headwinds for the company, I see these risks as already having been baked into the share price. I’m encouraged by the stabilizing NAV, and find the 14.5% dividend yield to be both safe and attractive. Lastly, the shares are currently trading at a wide discount to NAV, especially when compared to the recent past. As such, I have a Buy rating on the shares.
(Source: F.A.S.T. Graphs)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.