Business development companies have been weak so far this year. Many of these middle-market direct lenders have seen prices plunge by 20 to 30% or more this year as investor exited the sector in droves.
The selling began when the asset class was eliminated from the Russell indices due to accounting questions last year, which has continued into this year. Investors are concerned about where we are in the credit cycle and the possibility of Federal Reserve interest rates compressing spreads.
Rather than join the herd and flee the sector, this is probably a good time to consider buying the strongest BDCs and tucking them away for the long term.
My favorite pick in the space remains Apollo Investment (AINV).
Apollo Investment (AINV): Big Yield, Big Opportunity
This lender has a strong relationship with leading private equity and alternative asset manager Apollo Global Management (APO), and this gives them a unique advantage over many of its competitors.
For instance, Apollo will see deals and opportunities in direct middle market lending that its competitors simply will not see, allowing Apollo to cherry pick attractive loans.
Investors are worried about their exposure to energy and commodity related loans but management sees this space as more of an opportunity than a problem right now.
On the last earnings call Apollo CEO Jim Zelter told investors and analysts:
“We continue to be very focused on commodity-related investments, particularly oil and gas, and we have substantially exited any mining investments.”
Management is putting its money where its mouth is as well. Insiders, including Zelter and President Ted Goldthorpe, as well as several directors, were buyers of the stock as recently as August. They also announced a buyback, telling shareholders:
Consistent with our commitment to deliver shareholder value, we have adopted a $50 million stock repurchase program. Given where our stock is currently trading, we intend to begin repurchasing shares as soon as possible.
Apollo does have exposure to the oil and gas portfolio. Sixteen percent of the portfolio is in loans to energy related companies. While 82% of Apollo’s energy exposure is either first or second lien debt, so it is in a strong position to recover most if not all of its loans should a particular company default. Most of its portfolio energy companies are, like the larger publicly traded firms, cutting back on capital expenditures and putting cost cutting measures in place to protect cash flow and pay back debts.
Looking at the total portfolio, Apollo has investments covering 102 companies across 25 different industries. The average yield of the portfolio is 11.5% as of the end of the third quarter. During the second quarter it was making investments away from oil and gas, including loans to companies like Emergency Communications Network, the largest provider of emergency communication systems in the state and local government markets, and Deltek, an enterprise software company.
Shares of Apollo Investment are at five-year lows right now, and AINV stock trades at about 75% of net asset value and the shares are yielding 13.6% at the current price. It has a strong management team with loads of experience and deep ties to one of the world’s best private equity managers and strong credit backgrounds. Not to mention that management is buying shares of their company and Apollo has a buyback plan in place that should help support the share price.
Apollo is a great dividend play for income investors, but the real winners are going to be those who buy Apollo at the current depressed price and reinvest the dividend payments in more shares.
Steadily increasing ownership of a depressed asset will pay off with enormous returns for those patient and disciplined enough to hold them all they through the credit and economic cycle.
As of this writing, Tim Melvin was long AINV.