Logan Ridge Finance Corp: A small-cap BDC to consider for income

Introduction

As earnings traders, all of us have shares that we desire on account of their robust returns. Altria (MO) and Capital Southwest (CSWC) are a pair that come to thoughts once I assume corporations that deliver nice earnings to their shareholders.

However I additionally prefer to look for many who have nice potential to do the identical within the foreseeable future. Whether or not they’re going via a change of their enterprise mannequin or are a small cap firm that’s overlooking traders. One BDC I not too long ago got here throughout that matches this description Logan Ridge Finance Company (NASDAQ: LRFC). And on this article, I talk about the corporate’s fundamentals, current earnings, and why they may deserve a spot in your income-oriented portfolio.

Who’s Logan Ridge Finance Corp?

LRFC is a BDC, like lots of its friends, that focuses on lending to downgrade center and center market corporations via debt and fairness investments. They’re externally pushed and a few of their prime ten industries embrace protection sectors corresponding to Well being care, enterprise providers, data know-how, and Client items. The BDC IPO occurred about ten years in the past and is positioned within the state of Maryland.

A dependable earnings assertion

Regardless of lacking 1Q internet and complete funding earnings, Logan Ridge Finance Corp delivered a stable report. NII at $0.35 missed the estimate by a dime, and TII by $0.1 million. That was $5 million for the quarter.

Nevertheless, I feel BDC delivered a stable earnings report as a result of it managed to develop each the highest line and backside line quarter after quarter. Internet funding earnings was up about 59% from $0.22 within the earlier quarter, whereas complete funding earnings was up almost 14%. This was as a consequence of a one-time reversal of an accrued acquire of $0.6 million from a portfolio firm that was transferred to non-accrual standing within the prior quarter.

In addition they dedicated almost $9 million in capital to new and current portfolio corporations throughout the quarter, persevering with their path to unlocking development for the foreseeable future. Nevertheless, essentially the most spectacular efficiency of the quarter was that administration continued to benefit from the low cost to NAV of $33.71, shopping for again almost 22,000 shares.

The present program ends in March subsequent 12 months. And I count on administration to proceed shopping for again shares, which is prone to positively impression their NAV in addition to improve dividend security.

As well as, LRFC elevated its NAV from $33.34 within the prior quarter as a consequence of internet realized and unrealized positive factors and a rise within the dividend base. Buybacks at a reduction are important to BDC administration groups as a result of they assist NAV develop over time.

It additionally positively impacts their backside line over time. Nevertheless, NAV is down about $1 from $34.63 within the year-ago quarter. That is one thing that I usually prefer to see develop over time, and one thing that traders ought to preserve an in depth eye on transferring ahead.

Annual productiveness

Wanting on the firm’s current earnings, LRFC’s efficiency has been a bit blended, however nonetheless first rate given the difficult macro atmosphere. Additionally, administration has been looking for their footing since taking on in 2021 they usually have seen some positives since then. In addition they managed to attain their highest degree of funding earnings final 12 months, in addition to re-introducing a quarterly dividend.

NII was $1.43 for the total 12 months, nicely above their annual dividend payout of $0.96. Within the chart under, you possibly can see that LRFC’s financials are barely out of line with each internet funding and complete funding earnings falling over the past half of the 12 months. I’ll contact on them later within the article. Nevertheless, as talked about earlier, the present administration is getting into its third 12 months on the helm of the corporate. They usually appear to be heading in the right direction with share buybacks and new investments.

Portfolio high quality

One other metric that impressed me was the general high quality of the LRFC portfolio. Being a smaller cap BDC with a market cap of $60.5 million, their first lien ratio was stable at 66.5%. This was up from 65.4% within the earlier quarter. For context, smaller peer WhiteHorse Finance ( WHF ) had a first-lien publicity of 80.6%, whereas Monroe Capital ( MRCC ) was barely increased at 82%.

Nevertheless, administration is strengthening their portfolio by growing their publicity to collateralized loans, making them stronger to climate future headwinds. As well as, their debt portfolio had a a lot increased proportion of debt on the unique collateral – virtually 81%. Furthermore, it has steadily elevated over time, as will be seen within the chart under.

I additionally evaluate them to bigger friends Ares Capital ( ARCC ) and Capital Southwest , which have margins of 66.5% and 86.5%, respectively. So, by comparability, LRFC’s publicity is first rate. For some analysts, the upper degree of publicity to loans within the first place is usually a bonus when selecting a BDC.

Nevertheless, much less publicity doesn’t essentially imply underperformance, thus Ares Capital. BDCs can fight this by holding further capital within the type of a spillover. They will use this to cowl their dividends or lend to a non-performing borrower if they’re quickly in bother. And whereas the upper degree of publicity is a plus, it is not a deterrent for me to put money into the sector.

Furthermore, most of LRFC’s portfolio corporations carried out nicely at 93.1% with virtually 7% underperforming. This compares to WHF, whose portfolio corporations had been working at roughly 96% capability.

One factor to notice: WhiteHorse Finance’s portfolio is bigger at $697 million in comparison with Logan Ridge Finance’s $200.1 million. Moreover, WHF’s EBITDA vary for his or her portfolio corporations is increased at $50-350 million in comparison with the latter’s $5-50 million.

That is additionally one thing traders ought to think about, as these corporations could also be seen as riskier as a consequence of their smaller dimension. Furthermore, in the event that they face headwinds corresponding to the present macro atmosphere or a recession, this may even adversely have an effect on the monetary efficiency of their lenders.

Accounting stability

Logan Ridge’s stability sheet was stable, with $8.3 million in money and $23 million in obtainable liquidity on their revolvers. What’s extra, their debt maturities have been exactly calculated, with $50 million due in additional than 2 years in October 2026.

This had a weighted common rate of interest of 6%, which the corporate is prone to refinance at a decrease fee. After that, their subsequent maturity is not till subsequent Might with $75 million. Their leverage was barely increased than WHF’s 1.19x at 1.3x. Nevertheless, that is inside the vary of administration preferences and stays unchanged from final 12 months.

Dividend

Since resuming the dividend in 2023 after suspending dividends throughout the pandemic and switching from quarterly to month-to-month, administration has labored tirelessly to revive shareholder confidence within the firm. Since then, they’ve elevated their dividend by over 80%, which, all issues thought-about, is spectacular.

Moreover, they not too long ago elevated their distribution by 3% from $0.32 final quarter, making this their fifth improve in a row. And as a consequence of receiving dividends, LRFC’s dividend protection was 106%.

This compares to friends Monroe Capital and WhiteHorse Finance, which had protection of 100% and 122%, respectively. Nice Elm Capital Corp ( GECC ), one other smaller peer, had the identical protection of 106% as LRFC. Usually, I want to see increased publicity from my BDC holdings, however given the projected decrease rates of interest and share buybacks, I feel NII is prone to rise within the coming months.

Credit score high quality dangers

As talked about earlier, Logan Ridge Finance Corp is a smaller BDC with a market cap of lower than $100 million, which can be thought-about dangerous by some traders. Aside from this and their smaller buying and selling quantity, their smaller dimension additionally creates dangers related to their debtors.

Accruals had been increased than I’d have preferred to see at 8.7% and 6.8% of the portfolio at price and truthful worth respectively. That is up from 6.4% and 4.9% respectively final 12 months, doubtless on account of increased rates of interest. Of the three corporations, nevertheless, just one, Sequoia, a healthcare administration firm, has a big impression on the corporate’s funds.

Administration touched on that, saying the corporate nonetheless has some points to work out, however they’ve made progress on two others. Furthermore, as rates of interest decline within the coming months, I consider LRFC may even see a few of these corporations eliminated as monetary situations ease on account of decrease rates of interest. In that case, it might have a optimistic impression on their monetary efficiency, doubtless affecting their share value as nicely.

Additionally, if the financial system slips right into a recession, avoiding a gentle touchdown, this might result in additional will increase in defaults. Moreover, it might put debtors liable to chapter relying on the severity of the downturn. In that case, it might have a cloth impression on the corporate’s future monetary efficiency.

Evaluation

On the present value of $22.35 on the time of writing, this provides LRFC a reduction of almost 34%, decrease than the roughly 40% low cost over the previous 3 years. As you possibly can see from the chart, BDC has grown by double digits over the previous 12 months, doubtless on account of increased rates of interest and frequent will increase of their dividends not too long ago.

Because the begin of 2024, the share value has hovered within the $22-$23 vary, and I count on that may doubtless proceed as administration works in opposition to headwinds and focuses on development, which is prone to happen within the second half of the 12 months and subsequent 12 months 2025.

As well as, earnings are usually not anticipated to say no considerably over the subsequent two years, as are some friends. As returns decline on account of their floating fee portfolios, some BDCs will doubtless see a pullback because of this.

For BDCs, the present macro atmosphere has resulted in a slowdown in M&A exercise as sellers have been reluctant to behave over the previous 12-18 months. On this regard, LRFC will be a horny alternative to buy riskier however extra worthwhile shares at a reduction to NAV.

Wall Avenue and Quant appear very bullish on BDC, with robust purchase scores on each. Whereas I do not agree in the intervening time, they’ve plenty of potential and have not too long ago proven confidence by growing their dividend by 5. Nevertheless, regardless of this, their dividend protection and credit score high quality dangers stop me from improve them earlier than buy.

Last ideas

Logan Ridge Finance Company will be thought-about a dangerous however enticing funding alternative for earnings oriented traders. The BDC is making efforts to strengthen its portfolio with elevated credit score publicity within the first place.

As well as, their stability sheet is powerful with a transparent debt compensation ladder, growing flexibility for future dividend will increase. Nevertheless, they pose some important dangers as a consequence of their smaller dimension, decrease buying and selling quantity and the rise in defaults over the previous 12 months.

Additionally, regardless that they at present cowl the dividend, I might prefer to see how the BDC grows their internet funding earnings and in addition see a decline in accruals within the coming months earlier than contemplating elevating them. Consequently, I at present fee Logan Ridge Finance Corp as a maintain.

Editor’s observe: This text covers a number of small-cap shares. Concentrate on the dangers related to these shares.