PennantPark Investment Corporation (NYSE:PNNT) Q1 2024 Earnings Call Transcript

PennantPark Investment Corporation (NYSE:PNNT) Q1 2024 Earnings Call Transcript February 8, 2024

PennantPark Investment Corporation  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to PennantPark Investment Corporations First Quarter 2024 Earnings Conference Call. Today’s conference is being recorded. At this time all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the speaker’s remarks. [Operator Instructions]. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Investment Corporation. Mr. Penn, you may begin your conference.

Art Penn: Good afternoon, everyone. I’d like to welcome you to PennantPark Investment Corporation’s first fiscal quarter 2024 earnings conference call. I’m joined today by Rick Allorto, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements.

Rick Allorto: Thank you, Art. I’d like to remind everyone that today’s call is being recorded. Please note that this call is the property of PennantPark Investment Corporation and that any unauthorized broadcast of this call in any form is strictly prohibited. An audio replay of the call will be available on our website. I’d also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today’s conference call may also include forward-looking statements and projections. And we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to materially differ from these projections. We do not undertake to update our forward-looking statements unless required by law.

To obtain copies of our latest SEC filings, please visit our website at pennantpark.com or call us at 212-905-1000. At this time, I’d like to turn the call back to our Chairman and Chief Executive Officer, Art Penn.

Art Penn: Thank you, Rick. We’re going to spend a few minutes and comment on the current market environment for private credit, provide a summary of how we fared in the quarter ended December 31; how the portfolio is positioned for upcoming quarters; a detailed review of the financials; and then open it up for Q&A. For the quarter ended December 31, our GAAP and core net investment income was $0.24 per share. GAAP and adjusted NAV decreased 0.6% to $7.65 per share from $7.70 per share. As of December 31, our portfolio grew to $1.2 billion or 16% from the prior quarter. During the quarter we continued to originate attractive investment opportunities and invested $231 million and 12 new and 32 existing portfolio companies at a weighted average yield of 11.9%.

For the investments in new portfolio companies the weighted average debt to EBITDA was 3.7 times. The weighted average interest coverage was 2.4 times and the weighted average loan-to-value was 55%. Credit quality of the portfolio is stable. We had no new non-accruals in the quarter ended December 31. As of December 31, the portfolio’s weighted average leverage ratio through our debt security was 4.9 times. And despite the increase in base rates through 2023 and the portfolio’s weighted average interest coverage ratio was 2.2 times. On average, we have seen a 25 basis point tightening of first lien spreads. However, we continue to believe that the current vintage of core middle market directly originated loans is excellent. Leverage is lower, spreads and upfront OID are higher and covenants are tighter than in the upper middle market.

Despite covenant erosion in the upper middle market in the core middle market, we are still getting meaningful covenant protections. At December 31, the JV portfolio equaled $858 million and during the quarter, the JV invested $81 million including $8 million of purchases from PNNT. Over the last 12 months PNNT earned a 19% return on invested capital into the JV. We expect that with continued growth in the JV portfolio, the JV investment will continue to enhance PNNT’s earnings momentum in future quarters. Now let me turn to the current market environment. In an uncertain market environment, we are well-positioned as a lender focused on capital preservation in the United States. We continue to believe that our focus on the core middle market provides the company with attractive investment opportunities where we provide important strategic capital for our borrowers.

We have a long-term track record of generating value by successfully financing growing middle market companies in five key sectors. These are sectors where we have substantial domain expertise, know the right questions to ask and have an excellent track record. They are business services, consumer, government services and defense, health care and software and technology. These sectors have also been recession resilient and tend to generate strong free cash flow. The core middle market, which are companies with $10 million to $50 million of EBITDA is below the threshold and does not compete with the broadly syndicated loan or high-yield markets unlike our peers in the upper middle market. In the core middle market because we are an important strategic lending partner, the process and package of terms we receive is attractive.

We have many weeks to do our diligence with care. We thoughtfully structured transactions with sensible credit statistics, meaningful covenants, substantial equity cushions to protect our capital, attractive spreads, upfront OID and equity co-investment. Additionally from a monitoring perspective we received monthly financial statements to help us stay on top of the companies. With regard to covenants unlike the erosion in the upper middle market virtually all of our originated first lien loans have meaningful covenants, which help protect our capital. This is a significant reason why we believe we are well-positioned in this environment. Many of our peers who focus on the upper middle market state that those bigger companies are less risky.

That is a perception it may make some intuitive sense, but the reality is different. According to S&P loans to the companies with less than $50 million of EBITDA and a lower default rate and higher recovery rate than loans to companies with higher EBITDA. We believe that the meaningful covenant protections of core middle market loans, more careful diligence and tighter monitoring have been an important part of this differentiated performance. As a provider of strategic capital that fuels the growth of our portfolio companies in many cases we participate in the upside of the company by making an equity co-investment. Our returns on these equity co-investments have been excellent over time. Overall for our platform from inception through December 31st, we’ve invested over $448 million in equity co-investments and have generated an IRR of 26% and a multiple on invested capital of 2.1 times.

Since inception nearly 17 years ago, PNNT has invested $7.8 billion at an average yield of 11.3% and has experienced a loss ratio on invested capital of approximately 18 basis points annually. This strong track record includes investments of primarily subordinated debt made prior to the global financial crisis, legacy energy investments and recently the pandemic. With regard to the outlook new loans in our target markets are attractive, our experienced and talented team and our wide origination funnel is producing active deal flow, our continued focus remains on capital preservation and being patient investors. We want to reiterate our goal to generate attractive risk-adjusted returns through income, coupled with long-term preservation of capital.

We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily through debt instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. Let me now turn the call over to Rick, our CFO, to take us through the financial results.

Rick Allorto: Thank you, Art. For the quarter ended December 31, GAAP and core net investment income was $0.24 per share. Operating expenses for the quarter were as follows. Interest and credit facility expenses were $9.6 million, base management and incentive fees were $7.3 million, general and administrative expenses were $1.4 million, and provision for excise taxes were $0.4 million. For the quarter ended December 31, net realized and unrealized change on investments and debt, including provision for taxes, was a loss of $5 million or $0.08 per share. As of December 31, our GAAP and adjusted NAV was $7.65 per share which is down 0.6% from $7.70 per share in the prior quarter. As of December 31, our debt-to-equity ratio was 1.4x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt.

As of December 31, our key portfolio statistics were as follows. Our portfolio remains highly diversified with 139 companies across 30 different industries, the weighted average yield on our debt investments was 12.6%, PIK income equaled only 3% of total investment income. We had one non-accrual, which represents 1% of the portfolio at cost and 0% at market value. The portfolio is comprised of 58% first lien secured debt, 7% second lien secured debt, 9% subordinated notes to PSLF, 4% other subordinated debt, 5% equity in PSLF, and 16% in other preferred and common equity. 96% of the debt portfolio is floating rate. And debt to EBITDA on the portfolio is 4.8 times, and interest coverage is 2.2 times. Now, let me turn the call back to Art.

Art Penn: Thanks, Rick. In closing, I’d like to thank our dedicated and talented team of professionals for their continued commitment to PNNT and its shareholders. Thank you all for your time today and for your continued investment and confidence in us. That concludes our remarks. At this time, I would like to open up the call to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Mark Hughes of Truist.

Mark Hughes: I’ll go with the Mark Hughes part of that. Good. Good afternoon. Rick, what did you say the EBITDA coverage was on the overall portfolio?

Rick Allorto : So EBITDA was 4.8 times and the interest coverage was 2.2 times.

Mark Hughes : Yes. Thank you. And then any nuance now about the attractiveness of either subordinated debt or the preferred or common. The first lien is has obviously been attractive. But anything about the dynamic where you might see a little bit more of a preference for some of those other categories?

Art Penn: Yes. Thanks, Mark. And by the way just to clarify Mark Hughes is with Truist. And look we do invest across the capital structure. Obviously, it’s been really good to do first lien in this higher yield environment with the vintage and the good credit stats as well as classically will do equity co-invest to participate in some of the upside.. There are interesting second lien sub-debt and pref deals to look at. They just haven’t been that interesting relative to first lien recently. But we will continue to look. And if we have real conviction, we’ll potentially kind of take a look at adding some of that to the portfolio judiciously and carefully.

Mark Hughes : Thank you.

Operator: Next we go to the line of Robert Dodd with Raymond James. Please go ahead.

Robert Dodd : Hi, guys. And congratulations on the quarter. Just on the activity in the quarter, I didn’t catch this if you said in the prepared remarks. Can you give us an idea how much of that origination was really late in the quarter? Because it certainly looks like that you originated a lot interest income moved that much late did move right? So I presume a considerable portion of that was very late. But like just how much?

Art Penn: Yes. Thank you Robert. So about 40% of the origination was done in the month of December.

Robert Dodd : Got it. Thank you. And then looking — I mean as you said some of my questions have already been answered on a previous call. So some of the key sectors that you look at like business there is consumer government, et cetera, any change in relative attractiveness there? I mean in kind of the activity — the initial preliminary pipeline may be for the next — for the rest of the year. Is it concentrated in those sectors i.e., does it really mesh with your preferences? Or is how is that looking in terms of your potential opportunities by interest?

Art Penn: So, in general, look, we’ve been very active in defense and government services. We’re one of the leading lenders in that space given what’s going on geopolitically, we feel like there’s really nice tailwinds to that space. So we’ve been very active there. And for us, we’ve had a really good track record very stable steady and now potentially growing. Health care continues to be active for us. Now some of our peers have stumbled a little bit in health care. We’ve thankfully avoided some mistakes, and our way of looking at it and avoiding reimbursement risk, keeping leverage low, trying to get behind companies that are helping bring high-quality care to low cost has generally performed well from a credit standpoint.

And then business services, which is a big catch all. Business services can mean a lot of things. We’re active there. We’ve been less active in tech/software. It’s always been one of our smaller verticals. We’re — we lend against cash flow. We don’t lend against revenue and we lend reasonable levels of cash flow. So, we’ve — it’s a sector for us. It’s not one of our bigger sectors. And then consumer remains a sector for us. We’ve been a little bit more cautious there given some of the volatility around — potential volatility around the consumer. We’ve done better there when we’ve had brands that have some meaning. And we haven’t done a lot there recently, but if you look at kind of what’s worked for us and what hasn’t worked branded had meaning have worked.

So, it’s really been government services, defense, health care, and business services is kind of the big three for us.

Robert Dodd: Perfect. And on that point I mean you’d like to say business services is low white bucket so is health care. And to your point you didn’t do a lot of site position of its roll-up so things like that. So, reimbursement risk et cetera. I mean — so is the interest there? Is it the intersection between health care and government? Is it help care? I mean just you have had some successes in that area. So, I mean what’s looking particularly — maybe you don’t want to say on public call, but what’s looking narrower is in within that are looking good right now?

Arthur Penn: Yes, I mean there’s a number of different niches. It’s such a vast industry. It’s about 20% of the GDP of the United States. There’s so many different niches of care and services and synergies to be had among small or medium-sized providers and putting them together and then dealing with payers who want to get synergies around who they’re paying as well. So, we can — offline, we can go through some of the names in the portfolio but it’s a wide variety of different kinds of ways to articulate hopefully stable or growing health care niches with high free cash flow where you’re providing care at a reasonable cost that payers view as a reasonable cost. So, it’s enormous. We can certainly go to — going it offline but it’s all in there in the SOI statement of investments. and people can look and see go in Pennant and do the interpolation to the websites of these companies and see kind of the stuff we’re doing.

Robert Dodd: Got it. Got it. One last one if I can on credit. Obviously interest coverage et cetera that looks good. Obviously, there’s always going to be some marginal companies in the portfolio, but that’s always the case anyway. I mean in terms of trends? Are you seeing any emerging signs of weakness maybe not even in the portfolio but across businesses that are coming to market now? I mean it just seems everything is hanging in on a credit front-wise broadly much better than I would have thought if it’s me certainly like two years ago. So, is anything catching up to anybody yet? Or is it just everything picks along and everything is doing relatively fine?