The BDC sector remains a challenge from a shareholder return standpoint. As seen below, the VanEck Vectors BDC Income ETF (BIZD) has largely underperformed the S&P 500 (SPY), with a 29% decline since the start of the year.
While this may entice bargain hunters to start buying, I believe one should limit selections to high-quality BDCs with an adequate margin of safety. In this article, I’m focused on Solar Senior Capital (SUNS), which I believe is one such BDC. I evaluate what makes it attractive at the present valuation; so let’s get started.
A Look Into Solar Senior Capital
Solar Senior Capital is externally-managed by Solar Capital Partners and invests primarily in senior secured loans of private, middle-market companies. Its loan portfolio currently consists of 215 companies across 115 industries, with a portfolio fair value of $532M. I like the fact that 99% of the investment portfolio is invested in first-lien loans, which helps to shield against losses, as it is the last tranche of debt that a borrower would default against. It also helps to ensure recoverability in the event of a default.
As with most BDCs, the current operating environment has been challenging for Solar Senior Capital. This was evidenced by the 11% QoQ drop in NAV/share that the company saw in Q1. I’m encouraged, however, to see that NAV/share recovered somewhat in Q2, with a 6.6% sequential increase.
While the most recent quarter’s results point to an upswing, I also want to see what Solar’s long-term track record has been. As seen below, I pulled Solar’s NAV/share at Q4 of each year since 2015, along with that of Q1 and Q2 of this year. From the looks of it, it appears that management has done an adequate job of more or less preserving a steady NAV over the years, before the pandemic set in.
(Source: Created by author based on company press releases)
In addition, management has done a good job of preserving the net investment income over this same time period. From Q4 ’15 to Q4 ’19, the quarterly NII has been $0.35 for every quarter with the exception of two, in which it was $0.36 and $0.37.
Looking forward to Q3 results, I expect to see steady NII performance. This is supported by the resilient portfolio, in which 100% of the investments were performing at the end of Q2, and the fact that 82% of the loans have LIBOR floors, thereby capping the downside. In addition, I like the fact that mission-critical sectors of healthcare providers and insurance brokers represent some of the biggest industry exposures that Solar has.
Furthermore, the vast majority of the portfolio companies are deemed by management as essential businesses, in non-cyclical sectors. Lastly, the life sciences segment of the portfolio provides additional stability, as management noted on the last conference call:
“Now, let me turn to Life Science lending. Overall, our portfolio is largely insulated from short-term market and economic dislocations given the long-dated equity investment periods and product development cycles. The impact of COVID has had a de-minimis impact on the underlying Life Science portfolio. 100% of our loans are performing and we continue to expect to incur no losses in this segment.
As a reminder, we have never realized a loss in our Life Science investments. Currently, 100% of our Life Science portfolio have more than 12 months of cash runway. This is largely a result of our investment focus on public and venture capital backed late-stage pharmaceutical and medical device companies that are close to or entering commercialization.”
Meanwhile, Solar maintains plenty of liquidity, with $135M of cash and cash equivalents. The net debt to equity ratio is just 0.68 with no near-term debt maturities. I see this as being a big plus, as it enables Solar to make opportune investments and take advantage of market dislocations wherever they may arise.
I find the shares to be attractively valued at the current price of $13.37, which represents a 14% discount to NAV. This compares favorably to the 8% premium to NAV that the shares traded at on 12/31/19, based on the then price of $17.60 and the then NAV/share of $16.31.
In addition, the 9% dividend yield appears to be attractive in the current low-yield environment, and is currently covered by NII, at the newly set dividend rate of $0.10 per month.
I also like the fact that senior management has significant skin in the game, by owning 6% of the common shares outstanding. In addition, the CEO expressed confidence in the company by making two open market purchases within the last two months at the average price of $13.15, thereby increasing his stake in the company by 4%.
(Source: Open Insider)
Analysts seem to agree that the shares are undervalued, with a consensus Strong Buy rating (score of 4.7 out of 5), and an average price target of $15.67.
As with most BDCs, Solar Senior Capital has seen a drop in its NAV/share and portfolio NII due to the headwinds from COVID. However, I see the portfolio as being largely protected by the 99% senior loan structure, which helps to shield against losses, as it is the last tranche of debt that a borrower would default against. I’m encouraged to see that 100% of the loan portfolio was performing at the end of Q2, and expect to see steady NII performance in the upcoming Q3 results. Lastly, Solar maintains a strong balance sheet with plenty of liquidity, which should help it to take advantage of market dislocations wherever they may arise.
I find the shares to be attractively priced at the current price of $13.37, which represents a 14% discount to NAV. In addition, the 9% dividend is covered by current NII, and appears to be attractive in the current low-yield environment. For the reasons stated above, I see upside potential for the shares.
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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.