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Alcentra Capital: Analyst Upgrade

BDCs:
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On July 5, 2017 several news sources indicated a new rating was announced by DA Davidson for Alcentra Corporation (ABDC). Here are the details; an analysis of where the BDC trades currently and since going public and our own view of whether to pull the trigger on ABDC’s common stock:

BULLISH

DA Davidson initiated coverage of ABDC with a Buy rating, and a target of $15.0. We only have access to news accounts. We quote from streetinsider.com, itself quoting what the firm’s analyst said:

Analyst Arren Cyganovich comments “We believe its strategy of competing in a more fragmented lower middle market sized company and its access to the capital markets present the ability to grow its balance sheet. We believe its growth should provide stable dividends and potential for additional share appreciation. ABDC currently offers a solid dividend yield of roughly 10% with additional upside to our $15 target.”

At the Wednesday June 5 open ABDC was trading at $13.41. The $15 target price implies a 12% potential upside.

As the quote above suggests the current yield is 10.1%  and would be 9.1% at the $15 target.


ANALYSIS

The BDC News Of The Day does not undertake stock recommendations. However, we’ll place DA Davidson’s Buy recommendation in context to help our subscribers making up their mind:

The $15 price target is bullish and, if achieved, would be a new high for the BDC.

ABDC came public in 2014 at $15.00 a share but traded at $14.90 and then went down from there, reaching $10.36 in February 2016.

In 2017, the stock price recovered to reach a high of $14.48 before ABDC announced a secondary offering at $13.68.

The sale both raised new capital and allowed insiders to sell down their exposure and occurred in May.

The stock priced dropped in the wake of the new issue, to as low as $12.68 a month ago, but has been making its way back upward ever since.

VALUATION

At the current price, ABDC trades at 9.9x the latest recurring earnings annualized,  and at $15.0 11X.

That’s not a very high multiple compared to BDC favorites like Main Street Capital (MAIN) and Golub Capital (GBDC).

Using Closed-End Fund Advisors handy dandy BDC Universe table, we see ABDC’s 10.1% yield  is the tenth highest yield amongst the debt oriented BDCs they cover.

By contrast GBDC’s yield is 6.65% and MAIN’s 5.82%, far further down the yield table.

ABDC trades at or around its Net Asset Value price currently.

ROLLER COASTER

However – as mentioned above and judging from the price action in the last few weeks alone – ABDC can trade in a very broad range.

Going by DA Davidson’s Target and the February 2016 low ABDC has an upside from the current price of 12%, but also a downside of (23%).

This for a BDC which has never cut its $0.34 distribution in 3 years as a public company.

PROFILING

We think it’s fair to say that the higher yield and lower multiple ABDC is trading at – even if the stock price is close to record levels – reflects its perceived higher risk profile, tempered by a good track record to date.

Here is the BDC Reporter’s summarized assessment from a prior post:

Over the past 3 years, ABDC has performed relatively well, with a strategy of targeting “growth oriented” lower middle market companies. In general terms, the BDC’s portfolio risk profile is relatively high, with a goodly portion of capital in the junior tranches of company company structures and an average portfolio yield of 11.7% and spread over a relatively small number of borrowers. However, the Investment Advisor successfully navigated the BDC towards a much lower percentage of equity investments in the portfolio, from a third of the total at inception to 7% currently; managed to keep credit losses de minimis over the period and consistently earned and paid a $0.34 quarterly distribution.


OUR VIEW

We would argue that the likelihood of ABDC reaching DA Davidson’s price target will depend largely on two factors:

First, the general market attitude towards BDCs and leveraged credit vehicles generally, which is currently in a love fest across the board even if the BDC sector has dropped marginally from its March 2017 heights.

See the BDC Market Recaps for useful snapshots through the year.

Job 1

Second, how credit performance plays out in what is still an untested BDC which plays in the higher risk portion of the market. For example, the average portfolio yield at ABDC is 1.5x that of GBDC.

In this regard, our prior analysis suggests the BDC may have some credit challenges ahead which could affect earnings, which are already just meeting the dividend.

All our findings and conclusions are neatly contained in this May 18, 2017 post.

Sidelines

Given the credit uncertainties, as well as intangibles such as the Investment Advisor recently selling much of its ownership in the BDC and the dilution from the latest share offering and the ongoing “spread compression” in leveraged lending, we would rather be safe than sorry and avoid ABDC so close to its highs, even if the current price is at or slightly below NAV and at a double digit yield.

If the market priced ABDC in 2016 at $10.36 just a year and a half ago on strong earnings and an unchanged dividend what would happen if credit losses caused lower earnings/distribution. And if general market enthusiasm waned.

In our assessed that could readily bring ABDC to a sub-$10 price with only minimal negative news.

Given the limited upside and the potentially much higher downside, we would play the odds and stay away.

Either Way

However, to each their own and DA Davidson’s positive view and the market’s still bullish nature might yet bring ABDC back to its YTD high and beyond.

We’ll learn more about credit issues at the next earnings release, which could serve as a driver in either direction.

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