Solar Capital (
A Look Into Solar Capital
Solar Capital is a BDC that is externally-managed by Solar Capital Partners, LLC, and is a sister company to Solar Senior Capital (SUNS), which is managed by the same advisor. As of September 30, 2020, Solar Capital has a $1.5 billion investment portfolio that encompasses over 170 borrowers across 80 industries. Its largest industry exposures are healthcare, diversified financial services, and pharmaceuticals, with the common theme being non-cyclical, defensive sectors. Furthermore, Solar Capital has a rather conservative investment profile, with 99% of the portfolio being senior secured loans, and 91% as first-lien and 8% as second-lien.
Solar Capital has demonstrated resilience since the depths of the pandemic, with NAV/share improving slightly, from $20.11 in Q2’20, to $20.14 in Q3’20. This also represents a solid, 6-month, 4.6% improvement from $19.24 at the end of March this year. I’m also encouraged to see that the overall portfolio remains healthy with 100% performing loans, with no loans currently on non-accrual status. Plus, the weighted average internal risk rating remains unchanged on a YoY basis, at 1.9, on a scale from 1 to 5, with 1 being the lowest risk.
Looking forward, I see Solar Capital as continuing to fare well in the current economic environment. This is supported by its conservative investment profile of senior secured loans, and the by its defensive investment segments of asset-based lending, equipment financing, and life sciences. I find the life sciences segment to be particularly attractive, given the safety of this sector, and growth pipeline ahead, as noted by management during the last conference call:
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Overall, our life science portfolio has largely been insulated from short-term market and economic dislocations, given the long-dated equity investment periods as well as product development cycles. The impact of COVID-19 on our portfolio remains de minimis. As a reminder, we have never realized a loss in our life science portfolio. Currently, 100% of these companies have more than 12 months of cash runway.
During the quarter, the life science team originated approximately $5 million of investments and had repayments of just $1.5 million. Our pipeline for life science investments, including demand from larger, more mature companies, has increased going into this fourth quarter as financing needs have become clearer for these businesses.”
Solar Capital’s future pipeline is also supported by the record amount of private equity that is sitting on the sidelines. According to Institutional Investor, a record $69.1B was raised by venture capital funds this year, edging out the prior record set in 2018. As a BDC, Solar Capital relies on private equity sponsors for the equity side of the business, while it focuses on the debt side. Therefore, I see this news as being a net positive for Solar Capital going forward.
In addition, I also see the recent Kingsbridge acquisition as adding value to the bottom-line. Kingsbridge was a 2-year portfolio investment for Solar Capital, and is a leading independent lessor of information technology, industrial, healthcare, and commercial essential-use equipment to a diverse set of investment-grade customers.
Over 70% of Kingsbridge portfolio’s assets are leased by investment grade borrowers. Management expects this investment to generate approximately $20M of gross income in 2021. Doing back-of-the-envelope math, I calculate a 15.7% increase in gross investment income stemming from this acquisition, based on $127.5M in gross investment income (represented as revenue on the income statement) over the trailing 12-months.
Meanwhile, I see Solar Capital as being one of the better managed BDCs. This is supported by its track record of maintaining a steady book value per share (same as NAV/share), from $22.02 in 2011 to $21.44 in 2019 (pre-pandemic) timeframe, while maintaining a steady $0.40 to $0.41 quarterly dividend since 2013. In addition, Solar Capital maintains a strong balance sheet, with a pro-forma for the Kingsbridge acquisition net debt-to-equity ratio of 0.77x, which is well below the regulatory leverage limit of 2.0x, and below the company’s target leverage ratio 0.9x-1.25x.
Risks to Consider
As with all BDCs, Solar Capital’s has been impacted by low interest rates, as its weighted average portfolio yield has dropped on a YoY basis, from 10.7% in Q3’19, to 10.1% in the latest quarter. This, combined with a net portfolio activity of -$14.2M (loan originations less repayments) resulted in an NII/share of $0.34, which is down from $0.44 in the prior year quarter.
As such, the $0.41 quarterly dividend is currently not covered. However, I see potential for better coverage next year, given contributions from Kingsbridge, and from a resumption to normalized deal activity. Nonetheless, this is a risk worth monitoring.
Solar Capital has fared relatively well in the current environment, with a rebounding NAV/share since the depths of the pandemic. I find its conservatively managed portfolio profile to be attractive, and am encouraged to see that 100% of its investments are performing.
Looking forward, I see the Kingsbridge acquisition and the record amount of private equity sitting on the sidelines as being growth tailwinds for Solar Capital. Both of these factors should help with dividend coverage in future quarters.
Given the aforementioned, I find the shares to be attractively valued, at the current price of $17.21 and a price-to-book value of 0.85x, which, as seen below, sits below the 0.9x-1.0x level over much of the past 10 years. Analysts currently have a Buy rating on the stock (score of 4.0 out of 5), and an average price target of $18.46. Buy for income and growth.
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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.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.