Stellus Capital Investment Corporation (NYSE:SCM) Q4 2023 Earnings Call Transcript

Stellus Capital Investment Corporation (NYSE:SCM) Q4 2023 Earnings Call Transcript March 5, 2024

Stellus Capital 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: Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to Stellus Capital Investment Corporation’s Conference Call to Report Financial Results for its Fourth Fiscal Quarter and Year-Ended December 31, 2023. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] This conference is being recorded today, March 5, 2024. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Mr. Ladd, you may begin.

Robert Ladd: Okay. Thank you, Holly. Good afternoon, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter and year-ended December 31, 2023. Joining me, of course, this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements as well as an overview of our financial information.

Todd Huskinson: Thank you, Rob. I’d like to remind everyone that today’s call is being recorded. Please note that this call is the property of Stellus Capital Investment Corporation, and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone number and pin provided in our press release announcing this call. 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 differ materially from these projections.

We will not update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.stelluscapital.com under the Public Investors link or call us at 713-292-5400. At this time, I’d like to turn the call back over to our Chief Executive Officer, Rob Ladd.

Robert Ladd: Okay. Thank you, Todd. We’ll begin this afternoon by discussing our operating results followed by a life-to-date review, a review of the portfolio, including asset quality, and then the outlook.

Todd Huskinson: Thank you, Rob. First, I’ll cover operating results. We continue to benefit from our favorable asset liability mix, in which 98% of our loans are floating and only 27% of our liabilities are floating. As a result, we had solid results in the fourth quarter as we more than covered our $0.40 per share dividend through core net investment income of $0.50 per share and GAAP net investment income of $0.49 per share. Net asset value increased $0.07 per share to $13.26 per share. During the fourth quarter, we recorded a tax refund of $3 million. which was the result of recording a realized loss on previously marked down positions. Since our IPO in November 2012, we’ve invested approximately $2.4 billion in over 195 companies and received approximately $1.5 billion of repayments, while maintaining stable asset quality.

We have paid over $246 million of dividends to our investors, which represents $15.08 per share to an investor in our IPO in November 2012. Now, turning to portfolio and asset quality, we ended the quarter with an investment portfolio at fair value of $874 million across 93 portfolio companies, slightly down from $886 million across 96 companies at September 30, 2023. During the fourth quarter, we invested $40.3 million in 3 new and 11 existing portfolio companies and along with additional fundings of $3.9 million and received 5 full repayments and 4 full realizations, totaling $39.9 million, and $153 million of other repayments resulting in a net portfolio decline at cost of $39.5 million. At December 31, 99% of our loans were secured and 98% were priced at floating rates.

We’re always focused on diversification. The average loan per company is $9.9 million and the largest overall investment is $18.9 million, both at fair value. Substantially, all of the portfolio companies are backed by a private equity firm. The average leverage of the portfolio companies is around 4 times and average EBITDA of approximately $19 million per company. Overall, our asset quality is slightly better than plan, 24% of our portfolio is rated a 1 or ahead of plan and 14% of the portfolio is marked at an investment category of 3 or below. As of year-end, we had 4 loans on non-accrual, which comprised 1.3% of fair value of the total loan portfolio. And with that, I’ll turn it back over to Rob to discuss dividends and overall outlook.

Robert Ladd: Okay. Thank you, Todd. As a reminder, part of our investment strategy has been to invest in the equity of our portfolio companies in a modest way, but in order to generate realized gain sufficient to offset losses over time. While we’ve had modest equity realizations more recently, we expect this activity to pick up over the next 6 to 12 months. To this end, we are aware of two possible equity realizations that could occur in the second quarter. The aggregate proceeds of approximately $7 million and a potential realized gain of $4 million. As of the end of the year, we have $60 million of equity investments at cost that were marked at $72 million. Our historical performance would indicate that the ultimate realization for this portfolio would be greater than 2 times our portfolio’s cost basis.

However, of course, the ultimate performance of our current equity positions will depend on a variety of factors including, among other things, the current economic environment and sponsors equity [ph] exit strategies. Now turning to dividends, we continue to cover our dividend of $0.40 per share per quarter as a result of the greater earnings that we are generating in this higher interest rate environment. As Todd mentioned, we are well positioned to benefit from the higher interest rates as our portfolio is over 98% floating and our liability structure is approximately 73% fixed rate. Looking forward to Q2 of this year, we expect, subject to our Board of Directors approval, to continue our monthly dividend of approximately $0.13 per share, resulting in aggregate dividends of $0.40 per share for the second quarter.

It’s worth noting that based on the average price of our stock over the last 10 days ending yesterday, our current dividend equates to an annual yield of about 12.4%. Now turning to outlook, since year-end, we have funded $4.7 million at par in 7 existing portfolio companies and have received 1 full repayment of $16.2 million. This brings our total portfolio to approximately $863 million at fair value with 92 portfolio companies. We are experiencing a somewhat slower environment for originations than in the previous few quarters and we expect our funding for the remainder of the quarter will be offset by expected repayments of approximately the same amount. It is worth noting, we do expect for a variety of reasons that investment activity will pick up in the second half of this year.

We have substantial capacity for new investments which, of course, would increase with likely repayments. With that, we’ll open it up for questions. And, Holly, we can begin the Q&A session, please.

Operator: Certainly. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is from Paul Johnson with KBW.

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Q&A Session

Robert Ladd: Hey, good afternoon, Paul.

Paul Johnson: Good afternoon. Thanks for taking my question. So just on some of the remarks you gave on the portfolio, 14% or so, as fair value in your sort of internal risk rate at 3 or below kind of setting aside that not cool, I don’t think that accounts for 1% of that. Correct me if I’m wrong. I mean, how do you kind of think about those situations? I mean, do you think that those are situations you feel are stabilized and performing, albeit maybe below sort of projection? Or are any of these still is the work in progress?

Robert Ladd: Yeah. So Paul, as a general matter, we certainly think these are all manageable positions. They vary by company. The one attribute that would be true for substantially all of them is that they do have private equity ownership and backing and support. And so, I think, the way to think about our risk-grade 3s and below is perhaps performing under plan that combined though with private equity support, we think that the results are quite predictable. But, again, ups and downs in the portfolio, but I’d say no substantial change over our history.

Paul Johnson: Thanks for that, Rob. And then kind of looking in the next year, fee income this – other income, this year was relatively light. I mean, I’m just thinking about kind of activity, as you mentioned, if you expect to sort of pick up in the next year, you expect that to drive any sort of [central prepayment] [ph] come back to the year, depending on what sort of turnover, I guess, you’re expecting for the year?

Robert Ladd: Yeah, Paul, just in terms of, so one way to think about it, we had a little bit more than normal other income in the fourth quarter based on repayments. We think that slowed in the first quarter of this year, but we see repayments picking up toward the middle and latter part of the year. So, on balance, you’ll see it more, but just to flag that in the first quarter we would expect less of that other income than we had in the fourth quarter.

Paul Johnson: Got it. Thanks for the clarification there. And then last one for me, just on in terms of liabilities, I realize I think your unsecured notes are due in 2026, but there’s some SBA debentures that are rolling off in the next year or so. Where are you guys in terms of SBIC licenses and current capacity on those licenses?

Robert Ladd: Yes, so as a quick recap and then, Todd, will add in here. So we have 2 licenses currently. All of the debentures have been drawn which amount to $325 million. We do have some debentures from the first license that come due next year in 2025, roughly $25 million. So those will be prepared to retire, certainly honoring in advance of their coming due. And then, so we are looking at working with the SBA for a third license as we’ve reached some of the debentures from the first license that’s starting to come due. And our investment period for the second license is coming up toward the end of this year. So we’ll be in discussions with the SBA to see if we can obtain a third license.

Operator: Your next question is from Erik Zwick with Hovde Group.

Erik Zwick: Good afternoon. I wanted to start just on the comments, Rob, you made about expectations for funding to pick up in the second half of the year. And just curious if that is driven by kind of increase in pipeline activity that you’re saying or more based on kind of broad market developments or potentially a combination of both of those.

Robert Ladd: Yes, so probably, Erik, thank you for joining. So a variety of factors. So, certainly, when we’ve in over time, if things are slower, they tend to pick up, so that’d be one overall observation. But more importantly, we know there’s a tremendous amount of dry powder in all private equity hands, but especially in the lower-middle-market where we operate. We also know that there are holdings in private equity firms that are either the fun life is reaching an end or some continuation end. And there’ll be some realizations that private equity firms will start to generate. So our general impression is that things will pick up toward the second half of the year. We are seeing activity, but it’s not as heavy as it has been. So this is a more forward-looking to toward the end of Q2 and third and fourth quarters.

Erik Zwick: Thanks for that insight there. And then just looking at the 4Q funding activity as well as what’s been done quarter-to-date greater percentage of add-on new investments versus new and wondering if that’s just kind of based on the opportunities that you’re seeing or if you have a preference for those, certainly, companies that you’ve already made investments for and continue to grow, I’m sure you would love to build a continued support them. So curious about that mix, as we look at into 2024 what it could look like as well?

Robert Ladd: Sure. So, I’d say, we like both. We really like the new financing, where it’s an acquisition of a fresh company, fresh diligence, new equity capital. So that’s an ideal structure for us. But then, I’d say, equally as good would be an add-on where we already know the company, it’s performing well and they’re expanding This would be a lot of the strategy of the companies that we back is that the private equity firm takes the platform initial acquisition and then their plan is to grow it from here with add-ons or acquisitions if you will. So, again, both are attractive to us the add-ons come more naturally, and when we’re already in the credit. In terms of looking forward this year, we would expect many of our portfolio companies and their owners to be acquisitive. So you should see more activity there. But I think that that comes naturally with the existing and then, of course, we’re always searching for new opportunities and new companies.

Erik Zwick: Thanks. And then last one for me and I’ll step aside. Just looking at kind of the exits and some of the restructuring that took place towards the back half of the year, any expectations for what a PIK income may look like in 2024?